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A THEORY OF INTEREST 



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THE MACMILLAN COMPANY 

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A 
THEORY OF INTEREST 



BY 

CLARENCE GILBERT HOAG, A.M. 



THE MACMILLAN COMPANY 
1914 

^// rights reserved 



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Copyright, 1914, 
By the MACMILLAN COMPANY. 



Set up and electrotyped. Published February, 1914. 



MAR 12 1914 



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MY MOTHER 



PREFACE 

The purpose of this book is not to give a history of 
the problem of interest or to discuss in detail all the 
supposed solutions of it, but to try to solve it correctly. 

The importance of a correct solution can hardly be 
overestimated. Millions of men now call themselves 
party Socialists in countries where that party is com- 
mitted to the Marxian doctrine of interest, according to 
which interest is due to the exploitation of wage-earners 
by capitalists. Millions of men, in other words, on 
account of the theory of interest they have accepted, 
regard themselves as robbed by capitalists. By many 
party Socialists in the United States and elsewhere, 
indeed, the view is held that the capitalists themselves 
fully understand how the system robs the wage-earners, 
and sustain universities, whose professors defend it, not, 
as they pretend, primarily for the advancement of learn- 
ing, but primarily for the perpetuation of organized 
injustice. Such is the attitude, I say, of millions of 
persons at one end of the scale of political opinion. 
At the other end of the scale are the business men — 
the ''bourgeoisie," in the Marxian terminology — who in 
fact do not see any injustice in the receipt of interest, 
and who therefore in turn view the party Socialists as 
men who would rob them of their just accumulations. 
Neither group respects or understands the other. And 
the root of the whole misunderstanding, which breaks 
out into bitter struggles and dynamite plots today 

vii 



Vlll PREFACE 

and which may break out into civil war before long, is a 
difference in accounting for the surplus called interest. 
Marx's theory, which is accepted by acclamation by 
many wage-earners, seems wholly untrue to the few 
capitalists and the many professional economists who 
inquire into it. The theories of the professors and the 
capitalists, on the other hand, are hard to understand, 
and hopelessly at odds with each other. To the few 
leaders among the wage-earners who inquire into them, 
therefore, they are quite unconvincing. So the mis- 
understanding and the recriminations go on, and the 
political sky is full of warnings. 

All that is needed is light and moral courage. The 
light must come from those who study the problem of 
interest deeply and honestly. The courage must be 
furnished by the leaders of those political groups, in all 
lands, whose conceptions of interest must be modified 
in accordance with the light. 

Though inclined by my natural sympathies, on under- 
taking the study of interest, to take sides with the poor 
rather than with the rich if I could do so with intel- 
lectual sincerity, I was concerned, above all things, to 
discover the truth. And my conclusion is that, provided 
only a person's capital itself is equitably his own, his 
title to the interest accruing from it is as good as his 
title to the earnings of his hands. 

Here, of course, the Marxians and the Anarchists 
among my readers will be inclined to throw the book 
aside because its conclusion conflicts with their own. 
To such readers, therefore, I want to address two 
paragraphs. 

You who believe that interest is robbery, who, indeed, 



PREFACE 



IX 



as you would say, know that it is robbery, you who are 
sure that perpetual motion is as impossible in finance as 
it is in mechanics, do you dare to read this book and 
then to act honestly according to your convictions ? 
If interest does not involve perpetual motion in finance, 
and if it is involved in the very make-up of the world, 
nothing is to be gained by faihng to understand the 
truth about it and to modify your political and economic 
programs accordingly. 

Wage-earners and capitalists can understand each 
other and work together for the common good, as they 
cannot do now, just as soon as they agree on the interest 
problem ; and they will agree on that problem, obvi- 
ously, as soon as they both see the truth. The capi- 
talists are approaching the truth, under the guidance of 
the professional economists, who in the main are quite 
honest men. It is to be hoped that the wage-earners 
will approach the same truth from their side, under the 
guidance of their leaders, of whom, perhaps, you are 
one. To understand the interest problem will call for 
time and thought, but surely they are well bestowed 
for so great an object. To defend the truth among 
those who now oppose it will call for moral courage. 

Of the professional economists I must ask indulgence 
for using a terminology containing more new words and 
meanings than will at first seem to them necessary. 
My defence is that my whole theory is cast in a fresh 
mould, and I could not bring myself to be satisfied with 
expressing it in terms shaped by their associations with 
theories that will not fit my mind. I venture to hope 
that I have thrown enough fight on the problem to be 
partly excused for my innovations. 



X PREFACE 

The keystone of economic theory is the conception of 
value. Without a correct theory of value it was impos- 
sible to work out a correct theory of interest, and with- 
out a correct theory of interest it was impossible to work 
out correct theories of price and of distribution. This 
book makes in the theory of value some modifications 
that seem to me important. 

If my theory is to be called by a brief name, it should 
be called t/ie nominal value theory^ for the keystone of 
it is my conception of nominal value. 

The author to whom I owe most is Professor von 
Bohm-Bawerk, whose Capital and Interest and Positive 
Theory of Capital were very helpful to me. The follow- 
ing gentlemen have extended to me various courtesies, 
and it gives me pleasure to record my obligation to 
them : Professors Patten and McCrea of the University 
of Pennsylvania ; Clark, Seager, and Mussey of Colum- 
bia ; Taussig and Carver of Harvard ; Barrett and 
Wilson of Haverford College ; Mr. J. A. Hobson of 
England; Mr. Cyril A. Ward of Lausanne, Switzer- 
land; Mr. Arthur H. Thomas of Haverford, Pa.; and 
Mr. Charles L. Serrill and Dr. C. W. Macfarlane of 
Philadelphia. Mr. Ward was very kind in helping me 
in regard to the algebraic formulae. Most of all I am 
indebted to my wife. Without her encouragement and 
cooperation I could not have written the book at all. 

CLARENCE GILBERT HOAG. 

Haverford, Pa., 
April 15, 1913. 



CONTENTS 



I. The Problem 

II. Some Definitions and Fundamental Conceptions 

III. Theory of Normal Prices 

IV. Interest as a Price 

V. Relations of the Interest Problem Repre- 
sented Geometrically . . . 

VI. Causes of the Normal Rate of Interest 
VII. Other Theories of Interest 

'' Differences in Want and Provision for Want " 

" Underestimation of Future Pleasures and Pains ^ 

" Technical Superiority of Present Goods " 

" Productivity " . 

" Abstinence " 

Productivity and Waiting 

" Exploitation " . 

" The Fallacy of Saving " 

" Fructification " . 

The " Sacrifice Capital istique " 

The Monopoly Theory 
VIII. Interest in Relation to Wages and Rent 



INDEX. . . . . 225 



PAGE 
I 

II 

34 

47 

90 
100 
117 
117 
123 
124 
146 
149 

157 
159 
176 
178 
194 
203 

218 



XI 



A THEORY OF INTEREST 

CHAPTER I 

The Problem 

§ I . The facts of interest have presented a theoretical 
and a moral problem from time immemorial. Lending 
at interest was condemned by the Mosaic law ^ as be- 
tween Israelites ; it was declared by Aristotle ^ to be 
unnatural, was forbidden by the Roman Church until 
modern times, and is denounced by most Socialists 
today ; yet it persists age after age, and its justification 
seems to most business men too obvious for discussion. 
If we turn from moralists and business men to professed 
economists, we find that although most of them justify 
interest, they are well-nigh hopelessly disagreed as to 
the theory of its justification. The most no table, recent 
books on the subject, indeed, such as those of Cassel,^ 

^ E.g. Deut. xxiii. 19, 20: "Thou shalt not lend upon usury to thy 
brother . . . unto a stranger thou mayest lend upon usury. ..." 

2 Jowett's translation, as quoted in Macfarlane's Value and Distribu- 
tion, p. 140: "The most hated sort [of money-making], and with the 
greatest reason, is usury, which makes a gain of money itself, and not 
from the natural use of it. For money was intended to be used in ex- 
change, but not to increase at interest. And this term usury, which 
means the birth of money from money, is applied to the breeding of 
money because the offspring resembles the parent. Wherefore of all 
modes of making money, this is the most unnatural." 

^ G. Cassel : The Nature and Necessity of Interest, Macmillan & Co., 
London, 1903. 

B I 



2 A THEORY OF INTEREST 

Bohm-Bawerk/ Landry,^ and Fisher,^ offer theories so 
different that a faint-hearted inquirer would be tempted 
to give up the problem in despair. 

Confronted by such a variety of opinions, we should 
be justified in assuming, notwithstanding the views of 
business men to the contrary, that the facts of interest 
do present a problem, and that one of the utmost diffi- 
culty. Instead of making this assumption forthwith, 
however, let us analyze the facts briefly in connection 
with some of the most commonly accepted explanations 
of them, to convince ourselves at first hand of the diffi- 
culty of the problem and to get some idea of its nature. 

§ 2. The facts themselves are obvious enough. If 
you have $ioo to spare under any normal circumstances, 
you can get at least $3 in addition to the original hun- 
dred by lending it for a year under conditions that elim- 
inate virtually all risk. Furthermore, if you do not 
lend the $100, but invest it in machinery, you can nor- 
mally increase the value of your product for the year 
enough to cancel the cost of repairing the machinery so 
that it is as good as new, of insuring against its destruc- 
tion or its depreciation in value, and of making and over- 
seeing the investment, and to leave you at the end of 
the year a net surplus of at least $3. 

The apparent surplus of $3 that you get in the first 
case we shall call, with everybody else, loan interest. 

^ E. V. Bohm-Bawerk : Recent Literature on Interest, Macmillan Co., 
N.Y., 1903. 

2 Adolphe Landry : L'Interet du Capital, Giard et Briere, Paris, 1904. 

3 Irving Fisher : The Nature of Capital and Income, Macmillan Co., 
N.Y., 1906; The Rate of Interest, Macmillan Co., N.Y., 1907. 



THE PROBLEM 3 

The apparent surplus of the same amount that you get 
in the second case we shall call, for reasons that will 
appear later, natural interest} 

§ 3. It is against loan interest that the attacks of 
moralists have been mainly directed. The reason is evi- 
dent : in the case of loan interest the fact that the lender 
gets something of value that costs him no labor is per- 
fectly obvious ; whereas in the case of natural interest 
the apparent surplus — that is, the something of value 
which costs the recipient no labor — is noticed only when 
the several items that go to make up the cost, excluding 
any allowance for interest on the capital employed, but 
including outgo for repairs, insurance, and oversight, 
are carefully added up and compared with the receipts 
from the sale of the finished product. Recently, how- 
ever, natural interest has been attacked as vigorously 
as ever loan interest has been, notably by Karl Marx 
in his work Das Kapital, in which it is called "the 
average rate of profit." 

§ 4. That the bulk of the great sums constantly 
borrowed by business men nowadays are borrowed 
solely to secure natural interest, so that loan interest 
and natural interest are most closely connected and rise 
and fall together, is now realized by nearly everybody 
who thinks of the subject at all. Intelhgent men of 
affairs, such as bankers and manufacturers, look upon 
loan interest as simply the price of what we are calling 
natural interest. A loan yields interest, they say, be- 
cause it gives the borrower the opportunity to use, for 
the time covered by the loan, machinery or other things 

^ This definition is modified in § 2>2>' 



4 A THEORY OF INTEREST 

useful in production to the value of the sum lent. Of 
course, they add, some borrowers may not take advan- 
tage of this opportunity; but that should make no 
difference in its price : you must pay as much for a loaf 
of bread you throw away as for one you eat. Loan 
interest, they conclude, is the price of the opportunity 
to use labor-saving instruments to the value and for the 
time covered by the loan ; and it is just as fair that that 
opportunity should be paid for at its market price 
as that any concrete commodity should be. 

Now this is true enough so far as it goes ; indeed, it 
does not differ, practically, from the conclusion I shall 
sustain ; but to suppose, as many men of affairs do, that 
it leaves no problem of interest unsolved, seems amus- 
ingly naive either to a Marxian Socialist or to an academic 
economist. The Marxian Socialist asks how it is possi- 
ble, unless we are to believe in perpetual motion in 
finance, for natural interest to accrue to the owners of 
tools of production, admittedly without labor on their 
part, unless it is produced by somebody else's labor. 
He challenges such an owner to produce so much as a 
single pin with no worker to guide the machine. He 
scorns the notion of perpetual motion in finance, and he 
knows that ''surplus value," as he calls it, is produced 
by poor devils, down at the bottom somewhere, working. 
The economist, on the other hand, asks how we are to 
account for the fact that opportunities to get natural 
interest remain open age after age; and why natural 
interest, which seems to be a surplus of value added to 
the value of the product without extra labor but solely 
by the ^'productivity" of additional labor-saving in- 



THE PROBLEM 5 

struments, is not reflected back upon the price of those 
instruments when they are bought? If those instru- 
ments can produce such surplus value, why do they not 
have it? Why can they be bought, generation after 
generation, for prices below the sum of the values of their 
future services ? 

§ 5. These questions go deep. Whoever fails to see 
their significance has yet to understand what the interest 
problem really is. But they do not exhaust the diffi- 
culties which the explanation of the man of affairs fails 
to meet. What is to be said of the income that accrues 
to the owner of a ^'durable consumption good," such as 
a dwelling-house or a pleasure carriage, net above all 
cost of repairs and oversight, from renting it to others ? 
If that apparent surplus is not also interest, what is it ? 
And if it is interest, is it a mere reflection of the natural 
interest arising in connection with labor-saving instru- 
ments, or does it arise independently ? 

A little thought will reveal that it is interest and that it 
would arise even if there were no such things as tools in 
the world. Whether there were tools or not a stone 
dwelling would not sell for a price equal to the sum of all 
its future rents, reckoned net above the cost of repairs 
and so forth, to the end of time. And if discounting is 
applied to the values of the future services of the dwelling 
precisely as to those of the future services of tools, inter- 
est must accrue to the owner of the dwelling, as its 
future services come in, just as to the owner of the tool. 

§ 6. What, after all, is the cause of interest in any 
case but the discounting of future services to begin with ? 
If a man buys the future net rents of a dwelling or of a 



6 A THEORY OF INTEREST 

pleasure carriage for a price equal to all those future 
net rents discounted at 5 %, what is the cause of the 5 % 
interest on that price which he will receive as the years 
go by but merely the discounting to begin with ? Or if 
he buys a factory building and machines for a price 
equal to the values of all their future services discounted 
at 6 %, what is the cause of the 6 % interest on that price 
which he will receive on selling the finished product as 
the years go by but merely the discounting to begin 
with ? 

§ 7. All these questions are very perplexing to per- 
sons who suppose, as most of us not Marxians do suppose 
until we give special study to the problem, that interest 
is due to some imagined power on the part of labor- 
saving instruments to "produce" surplus value. They 
even suggest, indeed, that so far from interest's being 
produced by any such power on the part of labor-saving 
instruments, this supposed power is rather itself caused 
by interest, so to speak; for they suggest that this 
supposed power is a mere illusion due to the discounting 
of the price of the instruments at the beginning : and 
what is discount but interest itself in another aspect? 

At this point another question presents itself. Can it 
be that the supply of labor-saving instruments and the 
progress of invention have nothing to do with the rate of 
interest ? That we cannot believe : we are sure, whether 
we can incorporate it in a consistent theory or not, that 
there is some causal connection between invention and 
the rate of interest and between the supply of labor- 
saving instruments and that rate. We must admit that 
neither labor-saving instruments nor their undoubted 



THE PROBLEM 7 

usefulness can ''produce" surplus value, but we cannot 
give up the conviction that somehow interest is causally 
bound up with invention and the supply of such instru- 
ments. 

§ 8. Finally — and this might serve as a challenge 
to all theories of interest hitherto propounded — no one 
has quite solved the interest problem who has not fully 
explained just what it is that men discount when, as we 
say carelessly, they discount "future goods" or ''future 
services." No one has quite solved the problem, in other 
words, who has not fully explained the nature of what 
we call the principal. What is the principal? Two 
lots of goods or services, one of an earlier time and the 
other of a later — so much is obvious. It is obvious 
also that the two lots are conceived to be in some sense 
equal. But in what sense? Whole books are written 
without giving an answer to this apparently simple, and 
certainly fundamental, question. Some of the leading 
economists refer to the two lots as merely "present 
goods" and "future goods" or as "earlier goods" and 
"later goods," as if nothing less hopelessly vague were 
required. We must insist, however, on knowing, and 
knowing precisely, in what sense the two lots are 
equal. 

Are they, perhaps, equal in "kind and number," as 
Bohm-Bawerk ^ implies in some passages ? No ; for 

^Positive Theory of Capital, Macmillan & Co., London, 1891, p. 
237: "Present goods are, as a rule, worth more than future goods of 
like kind and number. This proposition is the kernel and centre of the 
interesttheory which I have to present." P. 248 : . . . "present goods, 
as a rule, have a higher exchange value and price than future goods of 
like kind and number." These passages are in Book V. In Book VI 



8 A THEORY OF INTEREST 

if I borrowed a ton of ice of you in July, agreeing to 
repay you with interest at 6 % per annum in six months, 
you would be far from satisfied if I repaid you in January 
with one and three-hundredths tons of ice of the same 
kind. Such an example, you may say, involves peculiar 
conditions. Pecuhar in degree, perhaps, but certainly 
not in kind. The only reason why you would not be 
satisfied with the one and three-hundredths tons of ice 
in January is that a given amount of ice has — in tem- 
perate climates, of course, and under usual circumstances 

— less value in January than in July ; and it is equally 
true, though in less striking degree, of innumerable other 
things, that the value ^ of any amount changes with the 
passing of time. 

Are the two lots of goods or services that are to be 
considered the principal equal in the amount of pleasure 

— or reduction of pain — that they afford any particular 
person or group of persons? To adopt this view in- 
volves the behef that when you or I or anybody else 
spends, instead of saving and investing at interest till 
some future time, the dollar he barely fails to save — ■ the 
marginal dollar spent, as we might call it — • he thereby 
necessarily sacrifices not a mere surplus of goods or 
services, but a surplus of pleasure. Can you beheve that ? 
I cannot. I have analyzed my motives critically, and 

Bohm-Bawerk writes: "In the previous book I tried to show, and 
account for, the natural difference that exists between the value of 
present and the value of future goods. I have now to show that this 
difference of value is the source and origin of all Interest on Capital." 
1 The word " value" I define in § 14 below. Here I use it in its most 
widely accepted significance, the significance that I give in § 14 to 
"nominal value." 



THE PROBLEM g 

I do not find that I am usually disposed to sacrifice a 
greater future pleasure for a less present pleasure ; and 
I find among my acquaintances others who believe them- 
selves equally free from improvidence. We all discount 
^'future goods" in some sense, of course; for example, 
we all frequently give up $1.02 next year in favor of 
Si this year ; but that is not to be identified with dis- 
counting future pleasure and pain unless it be shown that 
$1.02 of next year means more pleasure or more relief 
from pain than $1 of this year. Note that I do not say 
that nobody discounts future pleasures and pains con- 
stantly or that the most provident of us discount them 
never : I say only that many people do not discount them 
usually, and that therefore it is hard to believe that the 
true conception of the principal is two lots of goods or 
services on which are dependent equal amounts of pleas- 
ure or relief from pain on the part of any particular 
person or group of persons. 

Finally, then, are the two lots constituting the prin- 
cipal to be conceived as equal in value ? After our 
examination of the other two conceptions, this one 
seems more like the truth. Yet it is not without its 
difficulties. It is, indeed, contrary to a principle gen- 
erally accepted as fundamental for all economic think- 
ing and expressed as a definition of value by many 
writers, including J. S. Mill,^ Walker,^ Carver,^ and 

1 T. N. Carver: The Distribution of Wealth, Macmillan & Co., 
N.Y., 1904, p. 2: "In Walker's brief but excellent phrase, 'Value is 
power in exchange'; and as Mill defines it, the value of a thing is 'its 
general power of exchanging; the command which its possession gives 
over purchasable commodities in general.' Either definition expresses 
the whole meaning of the word value." The quotation from Walker 



lO A THEORY OF INTEREST 

Davenport.^ I mean the principle that "value is power 
in exchange." The lot of today and the lot of ten years 
hence that would constitute the principal of a loan for 
that time are obviously very unequal in "power in ex- 
change/' for the latter cannot be exchanged for the 
former unless a good deal of what we call interest is 
thrown in to boot. We must therefore give up either 
the idea that the two lots of goods or services con- 
stituting the principal are equal in value or the prin- 
ciple that value is always power in exchange; for the 
two are flatly inconsistent. 

§ 9. This short analysis suffices, perhaps, to show 
that interest does present a difficult problem and that 
the problem involves a fundamental aspect of the con- 
ception of value itself, the heart of all economic theory. 
Of this problem I shall offer now what seems to me an 
essentially correct, though doubtless very imperfectly 
developed, solution. 

is from his Political Ecoiiomy, Part I, § 8 ; that from Mill, from his Prin- 
ciples of Political Economy, Book III, Ch. i, § 2. 

1 H. J. Davenport : Value and Distribution, Univ. of Chicago Press, 
1908, p. 569. Davenport there defines value as "a ratio of exchange 
between two goods, quantitatively specified." 



CHAPTER II 

Some Definitions and Fundamental Conceptions 

§ lo. The object of all economic acts is increase of 
pleasure or decrease of pain. Its opposite is decrease of 
pleasure or increase of pain. The first group of alterna- 
tives I shall call in this book simply pleasure, the second 
group simply pain. 

Pleasure is dependent primarily on nature, but it is 
dependent also — and this is what concerns men practi- 
cally, and therefore what concerns economics — on 
human eforts and on an interval of time ^ between these 
efforts and the enjoyment of the pleasure dependent 
upon them. 

Up to a certain point efforts may be pleasant in them- 
selves. This point is soon reached, however, and be- 
yond it efforts are painful. To work in my orchard 
half an hour a day in good weather and when my inter- 
ests do not call me elsewhere may be distinctly pleasant ; 
but to work in it nine hours a day every working day of 
the year, or even every day when it urgently needs 
attention, is certainly somewhat painful. By the 
words pain and painful here I mean to cover not only the 
positive pain which must begin and increase as efforts 

^ This point about an ''interval of time" anticipates part of my 
theory which I cannot conveniently develop in the present chapter. 
The point will be duly supported in Chapter IV, § 37. 



12 A THEORY OF INTEREST 

are continued beyond a certain point, but also the nega- 
tive pain, as we might call it, involved in the cutting down, 
by such continuance of efforts, of the time ^ available for 
positive enjoyments. 

Efforts painful in themselves may be the cause of 
pleasure later. The ninth hour of the day in my orchard 
is painful in itself, yet it may be the cause of increasing 
or improving my crop of apples ; and the extra size or 
number or quality of the apples may give me pleasure 
when I come to eat them or to consume what they bring 
me in exchange at the market. 

At what point, then, will men naturally discontinue 
their efforts? In so far as men are rational they will 
discontinue their efforts where their total pleasure de- 
pendent on continuing ceases to be greater than their 
total pain on which continuing is dependent. 

§11. Efforts painful in themselves on which pleasure 
depends we call labor. I say ''efforts painful in them- 
selves" because we must exclude efforts exerted in sport 
or play : we must not make the definition too broad. 
But, on the other hand, we must not make it too narrow : 
we must not exclude efforts which, though pleasant in 

1 This bearing of time for enjoyment on pain was pointed out by 
H. H. Gossen in his Entwickelung der Gesetze des Menschlichen Verkehrs 
und der daraus fliessenden Regeln fiir menschliches Handeln, Brunswick, 
1854. It is covered by this theorem of his : "Given the option of sev- 
eral pleasures, and a time so limited as not to suffice for enjoying them 
all to the point of extinction, we obtain a hedonic maximum by enjoy- 
ing each pleasure in such measure that its intensity at the moment 
when the period of fruition expires is equal to that of every other pleas- 
ure." This note is based on p. 28 and p. 32 of M. Pantaleoni's 
Pure Economics, translated by T. B. Bruce, Macmillan & Co., London, 
1898. 



DEFINITIONS AND FUNDAMENTAL CONCEPTIONS 13 

themselves in some cases, are not forthcoming in suffi- 
cient quantity to meet the demand unless they are paid 
for. Examples of efforts of this sort are those of the 
first hours of the day in the case of many a professional 
man who enjoys his work. Extending our definition to 
include such efforts as these, we may put it thus : efforts 
on which pleasure depends that are painful in themselves 
or command a market price are called labor. 

§ 12. In some cases the pleasure dependent on efforts 
or on the interval of time mentioned in § 10 results 
directly, that is, without the intervention of any inter- 
mediate product. The results in these cases are called 
services. In other cases the pleasure results indirectly, 
the direct or immediate result being a good or commodity 
which in turn furnishes the pleasure itself. As an ex- 
ample of the services of a person take those of a violinist 
as he plays before an audience. An example of a good or 
commodity is the violin itself, which stands between the 
efforts of its maker and the pleasure that comes to the 
audience. Besides the services of persons we have also, 
of course, the services of goods : what the violin does 
towards making the music is its services. 

§ 13. We often think of goods or services as being 
such, that is, as being capable of affording pleasure, by 
virtue solely of an attribute — due to properties physi- 
cal, chemical, and the like — inherent in themselves. 
And this attribute we call their utility. Further analysis, 
however, reveals the fact that pleasure depends quite as 
much on the person pleased — on whether he exists, for 
example, and can avail himself of the good or service, and 
if he can, on his capacity for enjoying — as on the objec- 



14 A THEORY OF INTEREST 

tive nature of the good or service itself. Utility, indeed, 
loses all its meaning if the capacity of the person in 
question for being pleased under the particular circum- 
stances in question is left out of the case. Yet the mo- 
ment we give this capacity a precise meaning, in respect 
to the person as well as to the good or service, we can drop 
the word utility altogether in favor of others ^ that have 
not been associated so long with a vague, nay, an errone- 
ous, notion. I propose, therefore, to drop the word 
utility altogether from general use in this book. 

The conditions of a pleasure that are satisfied by what 
is inherent in a good or service, in short by the good or 
service itself, strictly speaking, may be called the objec- 
tive factor of pleasure ; those satisfied by the pleasure 
receiver, the person pleased, may be called the subjective 
factor of pleasure. There is no pleasure within the scope 
of economic inquiry that does not result from the co- 
operation of both these factors. 

The separation of these two factors seems to me a most 
helpful step in economic analysis. Without it the 
working out of a scientific theory of interest would be, 
in my opinion, a well-nigh hopeless undertaking. I 
presume it may have been made by others before now ; 
but if so, I do not know by whom. Possibly I am the 
first to develop and apply it. 

Let me emphasize the distinction between these two 
factors of pleasure by some simple examples. The 
pleasure I could get at this moment from a good peach 
would be greater than that I could get from a poor one. 

^ I mean the word ophelimity, proposed by Professor Pare to, and the 
word value, properly modified. See §§ 25-28. 



DEFINITIONS AND FUND ANIENT AL CONCEPTIONS 15 

The difference between the pleasures in this case is due 
to a difference in the objective factors involved, the two 
peaches. On the other hand the pleasure I could get 
from a good peach at this moment would be greater than 
that I could have got from the same peach last week 
when my appetite was weaker. The difference between 
the pleasures in this case is due to a difference in the sub- 
jective factors involved, the two persons to be pleased, 
the two capacities for enjoyment. Furthermore, the 
pleasure I could get from a perfect peach might be 
greater or less than that some other person could get 
from the same peach. In this case also the difference 
would be due to the subjective factors involved. / 

§ 14. We are now ready to consider what value is. 
The value of anything — good, service, or anything 
else ^ — is the amount of somebody's pleasure that is 
dependent on it, expressed as an attribute of the thing. 

It is therefore determined by the two factors of pleas- 
ure just defined, and those factors may be said to be 
factors of value as well as factors of pleasure. The 
value of anything depends, then, not only on what is 
inherent in it but also on somebody's capacity for getting 
pleasure from it ; and this last depends on the circum- 
stances under which it is available to a person, notably 
the degree to which he is already supplied with other 
things satisfying the same sort of want. 

This covers, it will be noticed, only the general con- 

^I say ''anything else" here not carelessly but because I want to 
include something that has value yet is not either a good or, in the 
ordinary sense of the word, a service. To cover "good, service, or 
anything else" I use sometimes the word "thing," so modified that its 
meaning cannot be mistaken. 



1.6 A THEORY OF INTEREST 

ception of value : it does not distinguish specific kinds of 
value . The specific kinds classify themselves readily, how- 
ever, according to the different sub jective factors involved. 

Thus there is the personal value ^ of a peach, its value to 
some particular person. This is determined by the 
attributes inherent in the peach, or by the peach itself 
— the objective factor — ■ and by the particular person's 
capacity under the circumstances for enjoying it — the 
subjective factor. 

There is also the market value ^ of a peach. This is 
determined by the same objective factor, the peach, in 
cooperation with — as subjective factor — the capacity 
to enjoy the peach, relatively to all other goods and 
services of the market, of any person having access to 
the market. Why ''relatively to all other goods and 
services of the market" ? and why "of any person having 
access to the market"? Because market value is a 
purely relative conception. It expresses not the amount 
of pleasure of a particular person that is dependent abso- 
lutely on the thing, but the amount of pleasure, of any 
person of the market, dependent on the thing relatively 
to that dependent on anything else of the same market. 
The amount dependent absolutely on a thing, a sack of 
flour for instance, varies enormously according to whether 
the person in the case is rich or poor ; but the amount 
dependent on a sack of flour relatively to that dependent 
on a pound of beef, a violin, or a dancing-master's ser- 
vices ^ — of any specified quafity, of course — is the same 

^ This is the "subjective use value" of many writers. 

2 This is the " objective exchange value " of many writers. 

^ This assertion is made on the assumption that at least a little of 



DEFINITIONS AND FUNDAMENTAL CONCEPTIONS 17 

for a millionaire as for a day-laborer having access to 
the same market ; for if it were different thus relatively, 
in other words if the value of a sack of flour relatively to 
the value of its price, say $1 — ■ which stands for a cer- 
tain amount also of beef, violins, and dancing lessons of 
any designated quality — were different to the two men, 
at least one of them would become a buyer or a seller 
of flour and a seller or a buyer of the other things until 
he made relative values to himself correspond with those 
of the market, as indicated by market prices, and there- 
fore with those to the other man of the two, who might 
similarly have eliminated, by buying and selling in the 
market, any temporary discrepancy between relative 
values to himself and relative values to the market. 

Of the other kinds of value which it would be possible 
to distinguish — according to the various kinds of 
subjective factor involved — we have need of distinguish- 
ing only one more. This is the value that differs from 
market value only in that its subjective factor, instead 
of being that of the particular persons constituting a 
market at a specified time, is that of whatever persons 
may constitute it at two or more different times. The 
need of this conception is felt when we want to compare 
the personal values or the market values of two lots of 
goods or services of different times. Suppose, for ex- 
ample, we want to compare the value to me of potatoes 

every one of the goods and services in question is demanded — at the 
market price, of course — by both of the two men in question. For 
the principles applying to goods or services no single unit of which is 
demanded by some of the persons constituting the market, see P. H. 
Wicksteed's Common Sense of Political Economy, Macmillan, London, 
jgio, Chapter VI. 
c 



1 8 A THEORY OF INTEREST 

this year with the value to me of potatoes next year. 
The comparison is no sooner mentioned than we want to 
make the lots of the two times "equal in value," so 
that ''the comparison will mean something." "Are we 
to suppose," we ask, "that the two lots are equal in 
value, that is, that each is a dollar's worth, say, and that 
the dollar itself remains constant between the times?" 
The answer being in the affirmative, we proceed con- 
tentedly to make the comparison until brought to a 
halt by the puzzling consideration that, from the point 
of view of the persons constituting the market at the 
earlier time, the dollar's worth of potatoes of the later 
time is less valuable than the dollar's worth of the earlier 
time by just what is called discount. Well, then, we 
must give up calling the two lots equal in "market 
value," and we must find out in what sort of value they 
are equal. And so we are driven to notice that it is to 
the market of the time at hand in each case that the two 
lots are equal. The market of the later time is that of 
the "same society," in a sense, just as the American 
nation of 1900 is the "same nation," in a sense, in 1913, 
but in another sense it is not the same. Old folk have 
died ; babies have been born ; and those living at both 
times have changed in needs and in resources. The 
later market is not identical with the earlier one, and 
to assume it to be so would be blameworthy even if the 
discount did not stare us in the face. As it is, with the 
discount before us to measure the considerable difference, 
in value to any particular market, between two lots of 
goods or services of different times that are equal in 
value to the market contemporary with each, we are 



DEFINITIONS AND FUNDAMENTAL CONCEPTIONS 19 

foolish indeed if we do not follow out to the end the dis- 
tinction between value to the particular market and value 
to the changing market, as I will call it, to see if it will 
not help solve the interest problem. This I propose to 
do ; and hereafter I shall call this value to the changing 
market nominal value. Nominal value, then, as I shall 
use the term, means the value whose objective factor 
is the same as that of the other sorts of value and whose 
subjective factor is that of the market of the time of the 
thing valued, not that of the market of the time of some 
other thing whose personal or market value is under- 
going comparison with it. 

§ 15. We come now to the conception of cost. In 
general the cost of anything — ■ good, service, or any- 
thing else — is the amount of somebody's pain on which 
it depends, expressed as an attribute of the thing. It 
is determined by two factors of pain corresponding to 
the two factors of pleasure already explained in § 13. 
The objective factor is simply the thing itself, objectively 
considered. This factor is obvious enough from the fact 
that under any given circumstances and for any person it 
normally requires more pain to make two wheelbarrows 
than to make one. The subjective factor of cost is the 
susceptibihty of the person in question, under the cir- 
cumstances, to pain in the thing's production. This 
factor is evident from a comparison of the pain required of 
a novice to make a wheelbarrow with that required of a 
skilful mechanic to make a similar one, or of that required 
of the mechanic when well with that required of the same 
man when ill. 

The several kinds of cost, personal cost, market cost, 



20 A THEORY OF INTEREST 

and nominal cost, correspond exactly to personal value, 
market value, and nominal value, and therefore need 
not be explained separately. 

§ 1 6. It is evident that according to these definitions 
anything may be the objective factor both of a value 
and of the cost with which that value is causally con- 
nected. The value to Smith, for example, of ten apples 
of specified size and quality may be said to be the 
arithmetical product of the objective factor, which we 
may call lo, and the subjective factor, which would be a 
number corresponding with Smith's capacity, under the 
circumstances, to enjoy the apples. The cost to Smith, 
on the other hand, of the ten apples would be the arith- 
metical product of the same objective factor, represented 
by the number lo, and the subjective factor, which would 
be Smith's susceptibility to pain, under the circumstances, 
in producing or otherwise acquiring the apples. The 
objective factor of value stands, indeed, between a 
pleasure on the one hand and the pain on which it de- 
pends on the other, the connecting causal link between 
them. If, therefore, we represent the amount of pleas- 
ure dependent on a thing and the amount of pain on 
which it depends, in other words the thing's value 
and its cost, geometrically instead of arithmetically, 
that is, by areas of two dimensions instead of by 
products of two factors, we may let a single line 
serve for both the thing's objective dimension of 
value and its objective dimension of cost. Tliis we 
shall do in § 25. 

If, in the case of the ten apples. Smith's subjective 
factor of value is 3 and his subjective factor of cost is 2, 



DEFINITIONS AND FUNDAMENTAL CONCEPTIONS 2 1 



we may represent the value and the cost of the apples 
to him geometrically thus : — ■ 



VALUE -30 

OBJECriVED/MENSION-fO 



\-SuBJECT/vE Dimension 

OF VALUE, 3 



7k 

I Subjective Dimension 

^ OF COST, 2 



COST-EO 



Butit will be remembered that pleasure, in terms of which 
value is measured, and pain, in terms of which cost is 
measured, differ only as going up the musical scale 
differs from going down it. Therefore there is no objec- 
tion to representing a thing's cost and its value by super- 
imposed areas thus : — 



Tje 



iSS! 



1 ^ 



Nfl^^ COST-20 



1^^ 



03J£CT//£ DIMBNSIOH-IO 

And this latter method is the one we shall adopt, because 
it reveals at once to the eye any difference there may be 
between the value of a thing and its cost. 

The causal relations, on the one hand between a thing 
and the amount of pain on which it is dependent, and 
on the other hand between it and the amount of pleasure 
dependent upon it, can also be easily represented 
to the eye. Let 10 P be the amount of pain on which 
the thing, 10 apples, say, is dependent. Then, if we 
let the direction from cause to effect be indicated by 
arrows, the causal relations are shown by the diagram 
below. At the point where a rational person ceases to 
produce the thing (see § 10) the amount of his pleasure 



2 2 A THEORY OF INTEREST 

dependent on another unit of it would just equal the 
amount of his pain on which the same unit would depend. 
Assuming the ten apples in question to be just this 
''marginal" unit, as it is called, the amount of the 
pleasure, p, dependent on the ten apples will be lo, and 
the diagram will be as follows : — 

iop» 



IO|v^ 




The net result, in terms of pleasure and pain to the per- 
son in question, of his producing those ten apples at the 
margin and then consuming them, is of course zero. 

This equality of the value and the cost of a thing to the 
producer at his margin may also be expressed, and for 
many purposes more conveniently, by an algebraic 
equation. Let A and B stand respectively for the ob- 
jective and the subjective factor of cost to the producer, 
and A' and B' respectively for the objective and the 
subjective factor of value to the producer. Then at 
the producer's margin we have the equation, 

AB = A'B'. 
Since A is the same as A', it follows, of course, that B 
must be the same as B^ Nevertheless we will let all 
four symbols stand in the equation, to show that all 
four factors are involved. 

§ 17. If two lots of things of the same time are equal 
in value to any person, the fact may be expressed by a 
similar equation. In this case A and B stand respec- 



DEFINITIONS AND FUNDAMENTAL CONCEPTIONS 



23 



lively for the objective and the subjective factor of one 
lot, and A' and B' respectively for the objective and the 
subjective factor of the other. Then again 

AB = A'B^ 

§ 18. Suppose it is the market values of these two 
contemporary lots, A and A'^, that we want to compare. 
That of A can be expressed by substituting for the per- 
sonal subjective factor, B, the market's subjective factor, 
which we may designate B'''. This subjective factor of 
the market cannot be an absolute magnitude, for the 
reasons explained in § 14 : it must be a relative magni- 
tude. Nevertheless it is just as real a magnitude, and it 
may be treated algebraically just as B may be. So AB'' 
stands for the market value of the thing A. As for the 
other thing. A', its market value is represented similarly 
by A' B'^\ the symbol B''' standing for the market's 
subjective factor in respect to A'. 

Now A and A' had the same value, as we saw, to some 
person. The question arises whether they have also 
the same market value. In other words does AB'' equal 
^/-g///p rpj^g answer is, normally, yes. Normally 
two lots equal in value to a person are equal in value to 
the market to which that person has access. The rea- 
son is not far to seek, and has already been mentioned 
in § 14 : when two lots valued equally in the market are 
temporarily valued unequally by a person having access 
to the market, he becomes a buyer of the lot he prefers, 
or a seller of the other lot, or both, and in so doing tends 
to make lots equal in value to himself equal in value to 
the market also. As all other persons having access 



24 A THEORY OF INTEREST 

to the market tend to do likewise under such circum- 
stances, there can be no equihbrium except when things 
equal in value to the market are equal also in value to the 
persons composing the market. 

The word '^ normally" demands explanation. By 
normally I mean, here and everywhere in this book, on 
the hypothesis that, excepting only the cause implied 
in the fifth paragraph of § 41 and referred to in § 68, 
no imperfections of the market or other causes prevent 
men^s acting according to their best economic interests. The 
word normal I use in a corresponding sense. I may add 
that for the formulation of the foundation of my theory 
of interest I shall assume normal conditions, not because 
they are the conditions of actual life, for that they are 
not, but because they furnish the best basis for our 
thinking. Of the divergencies of actual conditions from 
the normal I shall take due account before bringing this 
outline of my theory to a close. ^ 

§ 19. Going back to our equations of personal value 
and market value, we must not fail to note that although 
AB equals A'B', and AB'' equals A'B''', it must not be 
inferred that A'B' equals A'B'''. Of the relation be- 
tween A'B' and A'B'^' we know, indeed, nothing; for 
whereas A'B' is an absolute amount of pleasure, A'B'^' 
is a relative amount of pleasure. The personal values of 
different things correspond, it is true, to their market 
value ; but that is all we know. If a bushel of wheat 
stands at $1 in the market, and shoes of a certain sort I 
use at $4, I regulate my consumption of wheat and shoes 
so that the four bushels of wheat that equal one pair of 

^ See Chapter VI, § 72 and following sections. 



DEFINITIONS AND FUNDAMENTAL CONCEPTIONS 25 

shoes in market value equal one pair to me also ; and 
in so doing I affect the market value of both wheat and 
shoes infinitesimally myself. But to compare the abso- 
lute value to me of a pair of shoes with their market 
value (represented by the price $4) , which is not an abso- 
lute value at all but a relation between absolute values, 
is meaningless. 

§ 20. I cannot forbear to digress a moment to em- 
phasize the fact, doubtless obvious enough to many of 
my readers, that some of the great social reforms of this 
century must take their departure from the principle 
summarized in the last paragraph. At present there is 
nothing to prevent the indefinite production of goods and 
services which the market, indeed, demands, but whose 
cost to their producers is incomparably greater, absolutely, 
than their value to their consumers; and on the other 
hand there is nothing to insure the production of goods 
and services which, though not, indeed, demanded by 
the market, would have a value to their consumers far 
greater than their cost to their producers. This is only 
another way, of course, of saying that the aggregate 
happiness is greatly reduced by uneconomical distribu- 
tion. That distribution is economical, so far as the 
principle we are now considering is concerned, which 
unites each objective factor of pleasure, each concrete 
good or service or other valuable thing, with the greatest 
possible subjective factor or capacity for enjoyment. I 
need hardly add that I do not mean to suggest here any 
specific reform : I mean only to emphasize in its eco- 
nomic aspect a principle that confronts workers for the 
social welfare at every turn. 



26 A THEORY OF INTEREST 

§ 21. To return to our definitions and fundamental 
conceptions, the reader has been struck, no doubt, by my 
frequent use of the words *' depend" and ''dependent," 
my scant use of the words ''margin" and "marginal," 
and my definition of value without recourse to the phrase 
"marginal utility" at all. Such abandonment of ac- 
cepted terminology demands explanation. 

If I have a barrel of apples and lose two apples, my 
pleasure is reduced more than if I lost but one. Another 
way of saying this is that the amount of my pleasure 
dependent on the two apples is greater than that depend- 
ent on one. Moreover my pleasure is reduced more 
by losing an apple when I have only half a barrel than 
by losing it when I have a whole barrel. Another way 
of saying this is that the amount of my pleasure depend- 
ent on an apple in the one case is greater than that de- 
pendent on it in the other. It is clear from these exam- 
ples that the phrase "dependent on" covers fully the 
subjective as well as the objective factor of any pleasure 
or any pain, and therefore that it may be used to cover 
both factors when we want to define value and cost. 
Thus the phrase "marginal utility" becomes unneces- 
sary for the definition of value. And that is most for- 
tunate, for the word utility is so associated in men's 
minds with the delusion, explained in § 13, that the 
amount of pleasure dependent on a thing is determined 
solely by attributes inherent in the thing itself, as to be 
well-nigh ruined for scientific usage. The very expres- 
sion "marginal utility" impKes that there is such a thing 
as a non-marginal utility that is distinct from value, 
whereas in fact there is no such thing : non-marginal 



DEFINITIONS AND FUNDAMENTAL CONCEPTIONS 27 

utility means nothing unless the subjective factor be 
specified; and when the subjective factor is specified, 
the so-called non-marginal utility becomes simply a 
non-normal value. This unfortunate implication of 
"marginal utihty" rises up to trouble us when we come 
to drawing the two curves ^ required to illustrate graphi- 
cally the theory of normal prices. It leads to the des- 
ignation of the two curves as that of cost and that of 
utility. The theory of normal prices is greatly clarified, 
however, especially the theory of that normal price 
which we shall find interest to be, by designating the two 
curves as that of cost and that of value. This will all be 
made more clear in § 25, where the diagram of normal 
prices is drawn and explained. 

To show that my conception of dependence covers 
fully the conception usually covered by utiHty terminol- 
ogy, I venture to quote at length a classic passage from 
Bohm-Bawerk's Positive Theory of Capital? The italics 
in the passage are Bohm-Bawerk's. The words "de- 
pend" and "dependent" I have had printed in 
capitals. 

§ 22. "Turning now to the second question suggested 
in last chapter we ask, Of several or many wants which 
one is it that actually depends on a particular good ? 

"This question would not be put at all if the circum- 
stances of economic life were so simple that single wants 
always stood over against single goods. If a good were 
adapted to satisfy a single concrete want, and if it were 

1 See § 25. 

^Macmillan & Co., London, 1891. Book III, Chapter IV, pp. 
146-149. 



28 A THEORY OF INTEREST 

at the same time the only one of its kind, or, at least, the 
only one of its kind available, it would be quite clear 
without further consideration that the satisfaction of the 
single want depended on our command over the sin- 
gle good. But in practical life the matter is scarcely ever 
so simple as this ; on the contrary, it is usually compli- 
cated simultaneously from two sides. First, one and the 
same good is usually adapted to satisfy various concrete 
wants, which wants again possess various degrees of 
importance ; and, second, several goods of one and the 
same kind are frequently available, thus leaving it to 
caprice which good will be used for the satisfaction of an 
important, and which for an unimportant want. ... I have 
been shooting for a few days on the mountains, and by 
some accident I miss my companions. I am far from any 
house or village, and the only food I have for myself and 
my dog is two entirely similar baker's rolls. It is clear 
that the satisfaction of my hunger is of infinitely more 
importance to me than the satisfaction of the dog's 
hunger and it is just as clear that it lies with me which of 
the two rolls I shall consume and which I shall give to the 
dog. And now the question arises, Which of the two 
wants here is dependent on the bread ? 

''One is tempted to answer, That want to which the 
bread was actually devoted. But it is evident at once 
that this is an erroneous conclusion. It would amount 
to saying that the two rolls, devoted as they are to the 
satisfaction of wants of different importance, must 
possess different values ; while it does not admit of 
question that two similar goods, available under similar 
conditions, must be entirely equal in value. 



DEFINITIONS AND FUNDAMENTAL CONCEPTIONS 29 

''Here, again, an easy casuistical consideration gives 
the proper solution. The problem is. Which, among 
several wants, is dependent on a commodity? This 
resolves itself very simply when it is known which want 
it is that would Jail of its satisfaction if that commodity 
were not present : that want is evidently the dependent 
one. And now it is easy to show that the want which 
failed of its satisfaction would not be that want which 
the particular commodity was, accidentally and capri- 
ciously, selected to satisfy, but would always be the least 
important among all the wants in question ; that is to 
say, among all those wants which would formerly have 
been provided for out of the total stock of this class of 
goods. 

" Consideration for one's own convenience, as obvious 
as it is imperative, induces every reasonable man who 
acts economically to maintain a certain fixed order in the 
satisfaction of his wants. No one would be so foolish 
as to exhaust the resources at his command in satisfying 
trifling wants, or wants that could be easily ignored, 
and to deprive himself of the means of satisfying neces- 
sary wants. On the contrary, every one would take 
care to use the resources at his command, in the first 
instance, to provide for his most important wants ; then 
for wants that come after these in importance ; then 
for those of the third rank ; and so on, — always arrang- 
ing in such a way that the lesser wants were only pro- 
vided for when all the higher wants had been suppHed, 
and there still remained some means of satisfaction to 
spare. We act according to the same obvious and rea- 
sonable principles when our stock undergoes a change 



30 A THEORY OF INTEREST 

by the loss of one member of that stock. Naturally this 
will alter the plan according to which we have been em- 
ploying our resources. Not all the wants we had ar- 
ranged to satisfy can now be provided for, and some 
abatement in the totality of satisfaction is unavoidable. 
But, of course, the wise man will try to lay the burden 
on the least sensitive spot; that is to say, if the loss 
chances to be in a commodity which was destined to a 
more important use, he will not give up the satisfaction 
of this more important want, and, by holding on obsti- 
nately to his old plan, provide satisfaction for the less 
important wants. We may be sure that he will satisfy 
the more important want, and will do so by withdrawing 
provision from that want, among all the wants hitherto 
marked out for provision, on the satisfaction of which 
least DEPENDS. To put it in terms of our former illustra- 
tion : if our sportsman loses the roll which he has meant 
for himself, he will scarcely feed his dog with the one 
that remains and expose himself to the danger of starving. 
He will suddenly change his plan, elevate the roll that 
remains into fulfilling its more important function only, 
and shift the loss to the least important function, the 
feeding of the dog. 

''The case, then, stands as follows. Wants which 
are more important than this 'last' want will not be 
affected 'by the loss of the good, for their satisfaction is, 
as before, guaranteed in case of need by the replacement 
of substitutes. Nor will those wants be affected which 
are less important than this 'marginal want,' for they 
go unsatisfied whether the good is there or not. The 
only want affected is the last of those that otherwise 



DEFINITIONS AND FUNDAMENTAL CONCEPTIONS 31 

would be satisfied : it will be satisfied if the good is there ; 
it will not be satisfied if the good is not there. It is thus 
the DEPENDENT want we are seeking. 

''Here then we have reached the goal of the present 
inquiry, and may formulate it thus : the value of a good 
is measured by the importance of that concrete want, or 
partial want, which is least urgent among the wants that 
are met from the available stock of similar goods. What 
determines the value of a good, then, is not its greatest 
utility, not its average utility, but the least utility which 
it, or one like it, might be reasonably employed in pro- 
viding under the concrete economical conditions. To 
save ourselves the repetition of this circumstantial de- 
scription — which, all the same, had to be somewhat cir- 
cumstantial to be quite correct — we shall follow Wieser 
in calHng this least utility — the utility that stands on 
the margin of the economically permissible — ■ the eco- 
nomic Marginal Utility of the good. The law which gov- 
erns amount of value, then, may be put in the following 
very simple formula : The value of a good is determined 
by the amount of its Marginal Utility. 

''This proposition is the keystone of our theory of 
value. But it is more. In my opinion it is the master- 
key to the action of practical economic men with 
regard to goods. In the simplest cases, as in all the 
tangle and compHcation which our present varied eco- 
nomic life has created, we find men valuing the goods with 
which they have to deal by the marginal utility of these 
goods, and dealing with them according to the result of 
this valuation. And to this extent the doctrine of mar- 
ginal utility is not only the keystone of the theory of 



32 A THEORY OF INTEREST 

value, but, as affording the explanation of all economical 
transactions, it is the keystone of all economical theory." 

§ 23. The words ''depend" and ''dependent," as also 
such words as "affect," "effect," "result" (as noun or as 
verb), "product," "produce," and "cause" itself (as 
noun or as verb) , involve the conception of causation, 
and it is worth while to consider briefly what that con- 
ception, by which our thought binds events together 
according to their simultaneity and succession in nature, 
should really be. 

What, after all, do we mean by causation? What 
caused, for instance, the death of Julius Caesar? "The 
wounds," you may answer, "made by the daggers of the 
assassins." True ; but what if you had adduced, in- 
stead, "his own ambition," "his neglect of his friends' 
warnings," "loss of blood," or any of the many other 
conditions preceding his death without which he would 
not have died when he did. Any one of these conditions 
was as truly a cause of his death, in a sense, as the 
wounds. And we might extend the list indefinitely : 
if steel had not continued to cut flesh, for example, 
Caesar might not have died from the blows of the 
assassins. In a sense, then, the very properties of steel 
were a cause of his death ! Enlarging the conception 
thus, we finally have to say that the cause of any event 
is the condition and properties of the whole universe the 
instant before it. But the condition and properties of the 
universe an instant before the event in question were 
themselves caused by the condition and properties of the 
universe an instant before that. And so on ad infini- 
tum! Now, philosophically, this broadest conception 



DEFINITIONS AND FUNDAMENTAL CONCEPTIONS 33 

of cause has to be taken account of ; but for practical 
purposes it is useless : for practical purposes it must be 
narrowed until it includes, of all the prerequisite condi- 
tions, only those that have practical significance, that is, 
those that men can affect in their efforts to increase their 
pleasure. In this restricted meaning of the word cause, 
the cause of a man's death is the sum of those conditions 
preceding it that the man or somebody interested in 
him might conceivably have changed. It is this narrower 
conception of cause that we must adopt for the present 
inquiry. When we say that Smith's receiving a certain 
amount of pleasure "depends on ten apples," we do not 
mean to deny that the continuance in operation of cer- 
tain chemical and physiological laws concerned in the 
matter are necessary also to his receiving the pleasure : 
we mean to point out the apples as the one prerequisite 
condition of that pleasure which a practical creature like a 
man, that is, a creature who undertakes to affect condi- 
tions for his own ends, would do well to attend to. 
And likewise when we say that the ten apples "are de- 
pendent on," "are produced by," "are due to," "are the 
effect of," "result from," "are the product of," or "are 
caused by" a certain amount of somebody's pain, we 
mean to designate that pain, not as in any absolute sense 
the only prerequisite condition of the existence and avail- 
ability of the apples, but as the prerequisite condition 
that has practical significance. If we can discover all 
the practically significant prerequisite conditions of a 
rate of interest, we may say that we have discovered all 
the causes of that rate, in the only sense of the word 
causes that can reasonablv be used in economics. 



CHAPTER III 

Theory of Normal Prices 

§ 24. By the price of a valuable thing we mean the 
quantity of some other valuable thing for which it will 
exchange. Normally, in the sense of that word defined 
in § 18, the price of a thing would conform exactly to its 
market value (see § 14) when that market value itself 
was normal. A price conceived as conforming thus to 
the thing's normal market value is called a normal price. 

Though normal conditions may never hold in actual 
life, so that normal values and normal prices differ from 
any values and prices of the real world, the theory of 
normal prices is nevertheless most important for our 
purpose ; for the thing whose price is interest is a thing 
whose market, though not perfect, is at least exception- 
ally well organized, and whose price is more like a normal 
price than most prices are. Besides, any price, even 
one that diverges far from the normal, can best be under- 
stood by first understanding the norm from which it 
diverges and then the causes of its divergence. I propose, 
therefore, to proceed now with the theory of normal 
prices in general. 

We may start from the point of view of the individual. 
To him the production of each unit of the thing beyond a 
certain point must involve cost. This is inevitable with 
the definitions of cost and of pain given above in § 15 

34 



THEORY OF NORMAL PRICES 35 

and § 10 respectively. Beyond a certain point, too, the 
cost of successive units — our definitions of cost and of 
pain still holding — must rise ; and after it has begun 
to rise, it must continue to rise indefinitely. This will be 
found to be true even in the case of a producer excep- 
tionally fond of his work, such as a great pianist : even 
in his case the point must somewhere be reached — if 
not after the fifth or sixth hour of playing per day, as 
would seem likely, certainly before the twenty-fourth 
— where more playing becomes in itself painful, and 
from which point on each successive hour's playing must 
be more painful than the last. 

As for the value of the successive units of the thing in 
question, it must certainly decrease ; and eventually, if 
production is continued indefinitely, the value of another 
unit must fall quite to zero. If the producer were the 
great pianist, for instance, the money coming in to him 
from the seventh hour of playing daily would be applica- 
ble only to the purchase of luxuries little cared for, 
whereas that coming in from the first hour daily would 
be applicable to the purchase of necessaries and of luxu- 
ries really cherished. Increase the income thus indefinitely 
and the value of each unit would fall indefinitely until it 
reached zero. 

§ 25. The last two paragraphs justify us in repre- 
senting the cost of the successive units of any valuable 
thing by a curve that soon rises above the base-line and 
that continues to rise indefinitely; they justify us in 
representing the value of those units, on the supposition 
that each unit were marginal, by a curve that falls con- 
tinually and that would fall to the base-Hne if continued 



36 



A THEORY OF INTEREST 



indefinitely ; and they justify us also in making these two 
curves intersect. The curves are shown in the diagram 
below. Along LI lay off successive units of the (ob- 
jective) thing of value in question, in other words suc- 
cessive units of the objective factor of the thing's value. 
Along LK lay off successive units both of the subjective 
factor of its value and of that of its cost. Then, if the 
number of units produced by the individual in question 
is measured by LD, and the subjective factor of the 
cost to him of the last of these units is measured by DJ, 




Diagram I 

the cost to him of the last infinitesimal unit will be rep- 
resented by the area of a parallelogram whose length is 
DJ and whose breadth is infinitesimal, and therefore 
equally well by the mere length of DJ. The value, on 
the other hand, of the same last infinitesimal unit to 
the producer will be represented, if we suppose its 
subjective factor to be measured by DF, by a paral- 
lelogram whose length is DF and whose breadth is 
infinitesimal, and therefore equally well by the mere 
length of DF. 

If now we suppose the amount of the thing produced 
to be increased, the line representing the subjective 
factor of cost for the last or marginal unit will grow longer 



THEORY OF NORMAL PRICES 37 

and that representing the subjective factor of value for 
that same unit will grow shorter. A curve drawn 
through / and the limits of all the rest of these cost lines 
will therefore take some such form as CH ; and a curve 
drawn through F and the limits of all the rest of these 
value lines will take some such form as OR. Somewhere 
the two curves will intersect. If we designate the point 
of their intersection by W, then WV measures both the 
cost and the value to the producer of the last unit pro- 
duced when the whole number of units is represented by 
LV . Beyond the point V the producer will not normally 
go on producing, because the value to him of an additional 
unit would be less than its cost to him. Short of the 
point V, on the other hand, he will not normally cease 
producing, because short of that point the value to him 
of each additional unit is greater than its cost to him. 
Thus normally the amount of his production will be 
measured by LF, and normally the cost to him and the 
value to him of the last or marginal unit will each be 
measured by WV. 

Furthermore, the value of any unit before the last to 
the producer is the same as that of the last. This follows 
from what is called the principle of substitution, which 
was explained clearly in the passage about the two rolls 
quoted from Bohm-Bawerk in § 22. Since the last unit 
of the thing could at once be substituted for any unit 
before the last that might be put to a more important 
use, that is, made to cooperate with a higher subjective 
factor of pleasure, no more pleasure could be dependent 
on such a unit before the last than on the last one itself. 
And this is only another way of saying that no unit before 



38 A THEORY OF INTEREST 

the last could have more value to the producer than the 
last one. 

Does the same principle of substitution apply to costs 
also ? Does it operate so as to bring the cost of every 
unit before the last up to that of the last one? Cer- 
tainly not. Of course not, for, the cost of each unit 
being less and less as we recede farther and farther from 
the last one, that is, as we recede from V towards L, 
and cost being undesired by the person in question, that 
person has no incentive to substitute the higher cost of 
the last unit for the lower cost of any of the previous 
units. 

Instead of saying, therefore, that under normal con- 
ditions WV represents both the cost to the producer and 
the value to the producer of the last or marginal unit 
of the thing, we must say that under those conditions it 
represents the cost to the producer of the last unit and 
the value to him of any unit whatever. 

To sum up in words, then, the meaning of our dia- 
gram, we may say that the value ^ to a person of any 
unit of any thing falls, under the ideal conditions cov- 
ered by the word normal, to equahty with the cost to 
him. of the last, which is also the most costly, unit of 
his supply. 

From this theory of normal personal value to that of 
normal market value and normal prices the transition is 
short. Under normal conditions, as was explained in 
§ 14 (II4) and § 18 (Tf 2), market values must correspond 
with personal values, and market costs with personal 

1 For a modification of this assertion required by strict accuracy, 

see § 41 (H 5)- 



THEORY OF NORMAL PRICES 39 

costs. As this holds true for any person in the market, 
for any thing in the market, and for any supply of a 
thing, it follows that our diagram illustrating the theory 
of normal personal value will serve also for that of normal 
market value. Only in the interpretation of the dia- 
gram must there be a change : whereas in the personal 
cost- value diagram distance up from the base-Kne meas- 
ures absolutely the subjective factor of cost or of value, 
respecting a specified increment of a thing, on the part 
of a particular person, in the market cost-value diagram 
that dimension measures the subjective factor of cost 
or of value, respecting a specified increment of a thing, 
on the part of any person whatever and relatively to that 
person's subjective factor of cost or of value in respect 
to any other thing in the market. Applied to market 
values and market costs, then, the diagram means that 
the market value of any unit of any thing falls, under the 
ideal conditions covered by the word normal, to equality 
with the market cost of the last, which is also the most 
costly, unit of the supply. 

Having now in the explanation of the diagram a theory 
of normal market value, we have next to distinguish 
between that value and normal price. The difference is 
this : normal market value is an amount of pleasure — 
"the amount of pleasure dependent [normally] . . . 
relatively," etc., as explained in § 14 — whereas normal 
price is a concrete thing — any thing in the market that 
under normal conditions will exchange for the thing 
priced, or in other words anything in the market having 
the same normal market value as the thing priced. (I 
say "any" thing in the market because it cannot be 



40 A THEORY OF INTEREST 

denied, for instance, that a bushel of potatoes is the price 
of a circus ticket if it happens to exchange for a circus 
ticket. Usually, of course, the word price suggests to 
us money price only; but it must be recognized that, 
strictly speaking, any sort of valuable thing may be the 
price of any other.) The normal price of a unit of any 
thing, then, always corresponds to the normal market value 
of any unit of the thing and to the normal market cost 
of the last and most costly unit of it ; and the line of our 
diagram representing this value and this cost, namely 
WV, may be said to represent as well the normal price 
of a unit of the thing. 

§ 26. If we were asked to explain the causes of the 
normal price of any thing, we could now do so. Those 
causes must be the conditions of practical significance 
without which the price would not be what it is. These 
conditions, in turn, must be those that — to use the con- 
venient terms of the diagram — made the line IFF as 
long as it is and no longer. That means that they can 
be divided into two groups, those on the cost side, which 
determined the course of CH where it is to cross OR, and 
those on the value side, which determined the course of 
OR where it is to cross CH. This classification will be 
found very useful when we undertake to enum.erate the 
causes of the price called interest. 

§ 27. When we come to consider, in connection with 
the causes, on the demand side, of any normal price, the 
course of OR at points other than W, we find ourselves 
obliged to adopt some name for the reality represented 
by the height above the base-line of OR at those points. 
What, for example, does the height of OR at F, or in 



THEORY OF NORMAL PRICES 



41 



other words the length of the Kne DF, represent ? This 
question has aheady been broached in § 13 and § 21, 
but it requires further discussion. Does DF represent 
utiHty, as many writers^ would have it? Certainly 
not utility in the abstract, for that is not mensurable : 
if utility at all, certainly utility in conjunction with 
some specified subjective factor of pleasure, some speci- 
fied capacity to use. But, then, if what DF represents 
is a utility in conjunction with some specified subjective 
factor of pleasure, why call it utility at all ? That word 
has been spoiled for the designation of a mensurable 
attribute, partly by its everyday use in the sense of 
utility in the abstract. Modified by the word "mar- 
ginal," it has come in economics, it is true, to mean that 
mensurable quantity of pleasure, dependent on the thing 
in question, which is value. Yet how unsuitable it is 
to play the role it is playing in the term "marginal 
utility" — ■ which has become a sort of new corner-stone 
of economic theory — is apparent the moment we drop 
the "marginal" and try to apply the mere word utility 
that is left to things in the real world that differ from 
"marginal utility" only in not being marginal. Those 
things are to "marginal utility" just what all the lines 
between OR and LI, and parallel to WV, are to WV 
itself : in other words they are represented by the height 
above LI of the various points on the curve OR, being 
mensurable things which the unmodified word utility 
utterly fails to denote. 

1 See, for example, H. R. Seager's Introduction co Economics, Holt, 
N.Y., 1906, p. 86; C. W. Macfarlane's Value and Distribution, Phila- 
delphia, 1900, p. 55 ; and S. N. Patten's Theory of Prosperity, Macmillan, 
N.Y., 1902, pp. 22-25. 



42 A THEORY OF INTEREST 

§ 28. Objecting to the designation of the "relation 
of suitabihty between a thing and a man by the word 
utility, Professor Vilfredo Pareto of Lausanne proposed 
to substitute a word coined from the Greek co^eXt/io?, 
namely ophelimity. As this word was clearly defined by 
its coiner at the start in terms of the user as well as of the 
thing used, that is, in terms of what I call the subjective 
as well as in those of what I call the objective factor of 
pleasure, it has never meant anything else than the 
definite mensurable thing it was coined to mean. 
I regard it, therefore, as far preferable to the word 
utility, if one of the two is needed for the theory 
of value. 

But why is either word needed ? Why not call the 
things represented by the lines between OR and LI, and 
parallel to WV , simply non-normal values? Surely there 
is an advantage in calling them by a name that con- 
nects them directly with amounts of pleasure, as the 
word value, defined as I have defined it, does. Surely, 
too, there is an advantage in calling them by a name that 
indicates their logical relations with the costs represented 
in the diagram by the perpendicular hnes up from the 
same points on LF to the lower curve CH, as the word 
value, defined as I have defined it, does. And there is 
nothing, so far as I can see, to prevent the use of the 
word value for this purpose : what DF represents is a 
value just as surely as what DJ represents is a cost. 
The former is not, it is true, a normal value, under the 
conditions covered by the diagram; but neither is the 
latter a normal cost. The former is the value of any 
unit of the thing in question when the supply is measured 



THEORY OP. NORMAL PRICES 43 

by LD, just as the latter is the cost of the last unit of 
the thing in question when the supply is measured by 
LD. 

§ 29. That the reader may have the case in favor of 
the use of the word ophelimity fairly presented to him, 
I quote the following passage from the Precis d'Econo- 
mie Politique'^ of Professor P. Boninsegni, a disciple of 
Pareto and his associate in the University of Lausanne. 
I should quote from Pareto's own Cours d'Economie 
Politique^ if the passage on ophelimity there did not 
occupy many pages. 

''L'utilite^ ou la valeur d'usage des economistes est 

1 Lausanne, F. Rouge, 1910, pp. 2-4. 

2 Lausanne, F. Rouge, 1896, Vol. I. 

' The passage may be translated as follows : 

" 'Utility,' or 'value in use,' as used by economists, may have two 
different meanings. It may mean 

" (a) an objective attribute that things might have as being useful 
to men ; 

" (/3) a relation of suitability existing between a thing and men. 

"Value in use in its first meaning (a) has no sense; in its meaning 
(jS), while approaching the truth, it embraces an imperfect idea and is 
ambiguous. 

"I. It is imperfect: {a) because the utility or value in use of a 
thing is relative to the individual in question and not to men in general ; 
{h) because it fails to emphasize the fact that the utihty or value in use 
of a thing depends on the quantity of it that the individual in question 
has consumed or has at his disposal. 

"II. The ambiguity is due to the mass of different ideas and feelings 
that the term utility gives rise to on account of the different acceptations 
it has acquired in ordinary parlance as well as in the technical vocabu- 
lary of political economy and the other sciences. 

"The same observations may be repeated in respect to the term 
scarcity. 

"To avoid all these ambiguities M. Pareto introduced into the science 
a new term. He gives the name ophehmity to the relation of suita- 



44 A THEORY OF INTEREST 

susceptible de deux significations differentes. Elle 
peut exprimer : 

" (a) una propriete objective qu'auraient les choses 
d'etres utiles aux hommes ; 

" (^) un rapport de convenance qui existe entre une 
chose et les hommes. 

^'La valeur d 'usage dans sa premiere signification 
(a) n'a pas de sens; dans sa signification (/3), tout en 
se rapprochant de la realite, elle renferme une idee 
imparfaite et donne lieu a des equivoques. 

I. Elle est imparfaite: (a) parce que Futilite 



a ■ 



bility that exists between a particular individual and the quantity of a 
good added to a given quantity of the same good that the individual 
has already consumed or of which he has the disposal. 

"The ophelimity, for an individual X, of a quantity h of a good, 
added to a quantity a {a being possibly equal to zero) of the same good 
that the individual has already consumed or of which he has the dis- 
posal, is the pleasure which the quantity h gives him. 

"Suppose "I* (a) is the pleasure which is given to X by the consumption 
or the possession of the quantity a of the good in question, and # (a+A) 
the pleasure given by the quantity a -\- h oi the same good. Then the 
ophelimity of the quantity h is 

"Elementary ophelimity is the quotient arising from dividing by h the 
pleasure due to the enjoyment of the quantity k, provided, however, 
that h is very small (infinitely small) : 

limit MM=<|,'(a) 
no h 

"Elementary ophelimity per unit of price is the quotient arising from 
dividing the elementary ophelimity by the price. 

"If we indicate by p the price of the good of which the elementary 
opheHmity for X is *' (a) , then 

i$'(a) 
P 

is the opheHmity per unit of price." 



THEORY OF NORMAL PRICES 



45 



ou la valeur d'usage d'une chose est relative a un homme 
determine et non aux hommes en general; (b) parce 
qu'on ne met pas en relief le fait que Futilite ou la 
valeur d'usage d'une chose depend de la quantite que 
I'individu en a consommee ou dont il a la disposition. 

''II. Les equivoques proviennent de la foule d'idees 
et de sentiments divers que fait naitre le terme utilite 
a cause des differentes acceptions qu'il acquiert tant 
dans le langage ordinaire, qu'en economie politique et 
en d'autres disciplines. 

"Les memes observations peuvent etre repetees au 
sujet du terme rarete. 

"Pour ecarter toutes ces equivoques, M. Pareto a 
introduit dans la science un nouveau terme. II appelle 
ophelimite, le rapport de convenance qui existe entre 
un individu determine et la quantite d'un bien econo- 
mique ajoutee a une quantite donnee de ce meme bien 
que cet individu a deja consommee ou dont il a la dis- 
position. 

"L'ophelimite, pour un individu X, d'une quantite 
h d'un bien economique, ajoutee a une quantite 
a {a pouvant etre egale a zero) de ce meme bien 
que cet individu a deja consommee ou dont il a deja 
la disposition, est le plaisir que lui procure la quan- 
tite h. 

"Soient ^ {a) le plaisir que procure a X la consom- 
mation ou la possession de la quantite a du bien econo- 
mique en question et ^ {a-\- h) le plaisir procure par la 
quantite a-{- h de ce meme bien. L'ophelimite de la 
quantite h est : 



46 A THEORY OF INTEREST 

''L'ophelimite elementaire est le quotient du plaisir 
provenant de la jouissance de la quantite h par h, 
pourvu toutefois que h soit tres petit (infiniment petit) : 

limite A <J> {a) 



h = o h 



= *' {a) 



^'L'ophelimite elementaire ponderee est le quotient 
de la division de Fophelimite elementaire par le prix. 

"Indiquons avec p le prix du bien economique dont 
I'opheKmite elementaire pour X est ^' (a), 



J*'W 



est I'ophelimite ponderee." 



CHAPTER IV 

Interest as a Price 

§ 30. The thing whose price ^ is interest is not a 
good ; nor is it a service in the sense we have given to that 
word : it is rather the postponement of the consumption 
of a good or a service. Besides the objective and the 
subjective factor of value, therefore, which constitute 
what may be called the two economic dimensions of 
a good or a service, this postponement whose price is 
interest has a third dimension, time. Geometrically 
speaking, therefore, it is a solid, whereas the value of a 
good or a service is only an area or plane. Further- 
more, neither the objective nor the subjective factor 
of the value of some good or service, which factors 
constitute two of the three dimensions of the thing 
whose price is interest, necessarily remains uniform 
throughout the time that constitutes the third dimen- 
sion: all that is necessary is that their product remain 
uniform throughout. In other words the solid that 
represents the thing geometrically is not necessarily a 
parallelepiped like Figure I on the next page : it may be 
such a solid as Figure 11. 

This will be clear from the consideration of a concrete 
case. Suppose the good is eight suits of clothes whose 

^ For the correction required to make this assertion accurate in all 
cases, which would be a useless interruption at this point, see § :^s- 

47 



48 



A THEORY OF INTEREST 



total market value corresponds to the price $ioo. Then 
we may call the objective factor of their market value 8, 
and the subjective factor 12I; and we may represent 
their value geometrically by the rectangle A BCD 
in Figure I. Suppose, now, that the suits are lent by 
their owner to somebody else with the understanding 
that the principal of the loan is to be returned, with 
interest added, at the end of a time measured by DH. 



F' 




Figure I 



:^ 




al. 



IT^ 



Figure I' 



Then the area of the rectangle EFGH represents the 
value of the principal at the later time, and the whole 
soKd shown in Figure I represents the three-dimensional 
thing whose price is the interest. But EFGH is not the 
only rectangle that may represent the value of the 
principal of the later time : any other of the same area 
may represent it. Usually, indeed, lenders do not 
insist on the return of the identical goods, the eight 

^ For two notes on this figure, in addition to those in this section, 
see the third and fourth paragraphs of § 32. 



INTEREST AS A PRICE 



49 



suits, say, that they lend. To do so might, in the case 
of loans for a considerable time, be disastrous to them- 
selves ; for nobody can know that the identical goods 
will be as valuable next year as they are this year. 
What lenders want back, as "principal," is goods or 
services of the later time having the same nominal ^ 
value (see § 14) as the goods or services lent. So such 
an area as E'F'G'H' in Figure II, or any other area of 
100 units, may represent the value of the principal of 
the later time. As the chances are overwhelmingly 
against the later principal's having dimensions pre- 
cisely the same as those of the principal of the earlier 
time, I shall always use an irregular solid like that of 
Figure II rather than a parallelepiped like that of Figure 
I to represent the thing whose price is interest. 

For this three-dimensional thing whose price is 
interest we need a short name. I propose to call it an 
advance. An advance, then, as we shall use the word, 
is not to be confused with the goods or services advanced. 
The latter are things of two dimensions, whereas an 
advance is a thing of three, the third dimension being 
time. 

§ 31. Advances are of several sorts. I make an 
advance — whose cross-section, parallel with A'B'C'D' 
in Figure II, we may call 10 and whose time-dimension 
we may call 5 — when I lend you ten dollars for five 
years. That sort of advance is usually called a loan. 
I make an advance also if I rent you a house. This 
sort of advance is usually called a rent contract or a 

1 This sentence may serve temporarily as a definition of the prin- 
cipal. See §§ 34 and 35. 



50 A THEORY OF INTEREST 

lease. It differs from what we call the loan at interest 
in providing for the return of the identical good lent : 
if a certain house is advanced on a lease, it is expected 
that the very same house, not any other house or other 
thing of the same nominal value, will be returned at the 
end of the time stipulated. And as any particular dura- 
ble good usually dechnes in nominal value with the 
passing of time, on account of wear and tear, the good 
itself at the end of the time is usually not expected to 
sufhce for the principal of the loan, and the difference 
is charged in money and appears as the excess of the 
rent charged over what would be interest at the current 
rate on the market value of the good at the beginning 
of the time. As investors express it, "If you don't get 
enough rent from a building to yield you interest at 
the current rate above taxes, cost of repairs, and 
everything else that must be written off so as to leave 
your principal intact, the investment in the building 
is a bad one." 

A third sort of advance I make when I store up goods 
for future use, as when I store part of my harvest in the 
cellar for use in the winter, or when I store up my labor 
in some concrete thing — a table, say, a canoe, a fence- 
gate — whose services will not repay me for my labor 
for a considerable time. This sort of advance I make, 
indeed, even when I merely reserve for its future services 
a durable good which no person in his senses and under 
ordinary circumstances would think of treating other- 
wise but which it would give me more immediate pleasure 
to consume utterly at once, as when, for instance, I 
reserve my study-table for its future uses as such instead 



INTEREST AS A PRICE 51 

of burning it in the fireplace the first time I happen to 
be cold, out of fuel, and not especially in need of a table 
for the moment. For making an advance consists 
simply in giving up an earlier pleasure for a later pleasure 
(presumably greater). Nowadays, of course, in com- 
mercially advanced countries, this third sort of advance 
is often made by saving money or credit — either of 
which represents a claim on some of the market's goods 
or services — rather than by piling' up concrete goods 
or by investing one's own labor directly in a durable 
good ; but, equally of course, saving five dollars and then 
buying a wheelbarrow with the money is just the same, 
so far as our inquiry is concerned, as building the wheel- 
barrow with one's own saved labor. 

It is to be noticed that what is really advanced in any 
case is earlier services for later services. If I lend you 
ten dollars for five years, I make over to you a claim on 
the present market's services — those rendered by per- 
sons directly, those rendered by persons indirectly 
through goods, or those (of which the services of favored 
land sites are examples) rendered by nature or by 
society but appropriated by persons — up to a market 
value represented by ten dollars, in exchange for a claim 
on the services of the market of five years hence to the 
same nominal value, plus any interest that may be 
agreed on. If I rent you a house, I give you its services 
now in return for its services at the end of the time 
agreed on, plus the " rent." If I store apples in my cellar 
for winter use I forego their services — the word is odd 
in such a connection, but there is no harm in using it — • 
in the autumn to have instead their services in the 



52 



A THEORY OF INTEREST 



winter. If I store up some of my labor in a canoe that 
will not repay me for that labor for a considerable time, 
I am exchanging the services — of goods or of persons — 
that I could secure for that labor now for the services 
of the canoe some of which it will render me only after 
the lapse of months or years. As what is advanced is 
thus always, in the last resort, services, it is permissible 
to speak of it merely as services instead of as "goods 
or services," as I 'have done hitherto. It is, indeed, 
actually preferable to use the single word only, because 
doing so helps us bear in mind what it is that is in all 
cases really advanced. 

§ 32. Between the first and second sorts of advances 
on the one hand and the third on the other there is a 
distinction that we shall find to be of the greatest signifi- 
cance for the theory of interest. Advances of the first 
and second sorts are from one person to another; those 
of the third sort from a person to nature. Advances 
of the first and second sorts only shift the burden of 
making an advance-to-nature from one person's shoulders 
to another's, whereas those of the third sort actually 
lock up in concrete things of the physical world, or in 
the relations to each other of such things, services that 
will not for a considerable time be enjoyed to a nominal 
value equal to that of the labor they cost. 

The significance, for the theory of interest, of this 
difference between advances to persons and advances 
to nature appears when we undertake to apply to 
advances the theory of normal prices explained in the 
preceding chapter. When, for instance, the diagram 
of § 25 is to be used for advances, just what is it that 



INTEREST AS A PRICE 53 

is to be laid off along the base-line LI ? Are advances 
to persons as well as advances to nature to be laid off 
on it? The question is very puzzling until we realize 
that an advance to a person is nothing but the sale to 
him of an advance to nature. Then it becomes clear 
that the only stock of advances that corresponds, in the 
theory of the normal price of advances, to the stock of 
any sort of goods or services in the theory of the normal 
price of goods or services, is that of advances to nature ; 
and that advances to persons, being really only sales of 
advances to nature — or at least of opportunities to 
make such advances — do not affect the normal price 
of those advances any more than the sale of a table, 
once or a dozen times, affects the normal price of tables. 
Nothing affects the normal price of tables that does not 
affect the curve CH or the curve OR as applied to 
tables ; nothing affects the normal price of advances that 
does not affect the curve CH or the curve OR as applied 
to advances ; and neither the sale of a table nor the sale 
of an advance to nature does affect either of these 
curves, for the reason that, so far as these curves are 
concerned, such a sale's effect on the buyer and its effect 
on the seller exactly cancel each other. 

It will be evident without detailed explanation that 
an advance to nature is represented by Figure II of 
§ 30 just as well as an advance to a person is. When 
that figure represents an advance to nature, the area 
A'B'C'D' represents the nominal value, 100 (corre- 
sponding to the price $100), of services D'C which are 
invested in an advance to nature ; and the area E'F'G'H' 
represents the nominal value of the services H^G' of 



54 A THEORY OF INTEREST 

the later time which constitute the principal of that 
time. 

In this connection I will say that it must be admitted 
that when a person makes an advance to nature, and 
often even when he makes an advance to a person, he 
does not receive back his principal at the later time in 
one lump, so to speak, as represented by my figures in 
§ 30 and by Diagram III of § 52, but little by httle. 
We are not misled, however, by imagining the existence 
of a sort of centre of gravity of these returns that con- 
stitute the principal, and by treating the point of time 
of that centre of gravity as equivalent to the point of 
time at which the principal is returned all together 
when it is returned thus. 

§ 33. The correspondence of the two kinds of ad- 
vances, those to persons and those to nature, with the 
two kinds of interest mentioned in § 2, loan interest and 
natural interest, hardly requires pointing out. But we 
must be careful how we interpret the correspondence. 
We may be inclined to jump at once to the conclusion 
that loan interest is always the price of an advance to 
a person and natural interest always the price of an 
advance to nature. But although the former of these 
conclusions is true always, the latter is true only in some 
cases. Take the case of a manufacturer : he buys the 
services of one time, those of a factory building, of 
laborers and superintendents, of raw materials, and so 
forth, and he sells the services of a later time, those of 
the products he manufactures, which later services are 
the effects of which the earlier services were the causes ; 
and the natural interest that normally accrues to him 



INTEREST AS A PRICE 



55 



from the transaction appears in the concrete form of a 
difference between the money paid for the earher ser- 
vices and that received for the later. In his case, there- 
fore, the natural interest accruing might be called a 
price, the price of the advance to nature in which the 
investment necessary between the two times is embodied. 
But in the case of a person who does not both buy the 
earher services and sell the later, the natural interest, 
though it may, indeed, accrue, does not appear in the 
concrete form of a difference between prices, and there- 
fore need not necessarily be called a price. For exam- 
ple take the case of a man who buys a pleasure carriage 
at one time and enjoys its services at later times. In his 
case the natural interest normally accruing may be 
regarded in either of two aspects : it may be regarded as 
the difference between the price paid for the earlier 
services (those invested in the building of the car- 
riage) and that which would have been paid for the later 
services (those rendered by the carriage) if these latter 
had been bought apart from the carriage itself and at 
the times at which they were to be rendered ; or it may 
be regarded as the difference between the pleasure 
which the price spent on the carriage would have 
afforded if it had been spent on immediate enjoyment 
and the pleasure afforded by the carriage on the many 
later occasions when it is used. Regarded in the former 
aspect, it is a price ; regarded in the latter aspect, it is a 
value. If now we consider a third kind of case, that of 
a person quite isolated from the market for services, 
like Crusoe, we find one in which, though natural inter- 
est may accrue, it cannot possibly be calculated in 



56 A THEORY OF INTEREST 

terms of price, for the reason that there is no such 
thing as price in Crusoe's world. That natural interest 
may accrue to Crusoe is demonstrated later in this 
chapter (§ 51). That in his case it must be reckoned in 
terms of pleasure and pain only is evident from the mere 
fact that neither his services nor those of the goods he 
may make, or may possess without making, are men- 
surable objectively in terms of prices : they are men- 
surable only in terms of his own pleasure and pain. — 
Having thus carefully qualified the statement that 
natural interest is the price of an advance to nature, I 
shall allow myself sometimes, hereafter as hitherto, 
when convenience seems to require it, to speak of interest 
as if it were always a price. 

§ 34. Before undertaking now to apply to advances 
the theory of normal prices developed in the previous 
chapter, it will be well for us to review some points of 
the definition of advances. ^ 

An advance is not to be confused, in the first place, 
with the services advanced or with their value to any 
person or market : the services are to their value — 
either their value to any person or their market value — 
what a line is to an area ; and their value is to the ad- 
vance itself what an area is to a solid. In Figure II 
of § 30 the hne D'C , the line H'G\ or any Hne in the 
solid parallel with these, represents the services advanced 
in the case. The plane A'B'C'D' , on the other hand, 
or any plane in the solid parallel to it, represents the 
nominal value of those services. And finally the whole 
sohd represents the advance itself, the third dimension 
of the advance, namely time, being represented by the 



INTEREST AS A PRICE 57 

distance between the plane A'B'C'D' and the plane 
E'F'G'H'. 

In the second place, the nature of that subjective 
factor of value which is part of the definition of the prin- 
cipal must not be lost sight of. In Figure II of § 30 
that subjective factor is represented, of course, by 
A'D' or any other line parallel to it, in other words 
by the up-and-down dimension of the plane A'B'C'D' 
or of any other plane parallel to it in the solid. In the 
case of an advance to a person it is always the subjective 
factor of nominal value, that is, the subjective factor 
of value to the market of the "changing society" — • 
existing at the successive moments of a passing time — 
explained in § 14. In the case of an advance to nature 
by an advancer who has access to the market for 
services, it is the same. In the case of an advance 
to nature by an advancer who does not have access 
to the market for services, it cannot be the subjective 
factor of nominal value, because there is no such thing 
as nominal value in the world of such an isolated ad- 
vancer : in his case it must be something else, as ex- 
plained in § 51. 

§ 35. For the present we shall confine ourselves to 
the consideration of advances made by persons having 
access to a market for services. Of such advances the 
principal, as explained above, is two lots of services of 
two separated times but of the same nominal value. 
The subjective factor of the principal of such advances, 
in other words, is the need of, or capacity to receive 
pleasure from, the services in question, on the part of 
the society that happens to constitute the market at the 



58 A THEORY OF INTEREST 

moment, relatively to the same society's need of, or 
capacity to receive pleasure from, any other thing in 
that market. To lose sight of this point of the definition 
of those advances to which we shall now apply the theory 
of normal prices, is to miss the true solution of the in- 
terest problem, for this point is the elusive secret of that 
problem. 

Of the two sorts of advances made by persons having 
access to a market for services, advances to persons and 
advances to nature, the former are to the latter, as ex- 
plained in § 32, exactly what the sale of a suit of clothes 
is to the investment of services in making it. The point 
is important and may well be explained here again more 
fully. 

Making an advance to a person can no more affect the 
price of advances than selling a suit of clothes can affect 
the price of suits, for making an advance to a person is 
virtually selling that person an advance to nature of the 
same dimensions. My lending you $100 for a year 
makes it possible for you to invest your labor to the value 
of $100 in an advance to nature, for example in making 
a durable good worth that amount, just one year be- 
fore you could do so without the loan unless you en- 
croached to that extent on your leisure or on the labor 
you wanted to devote to other ends. It is therefore 
simply selHng you an advance to nature of the same 
dimensions. And such a sale cannot affect the price 
of advances to nature because it neither increases nor 
decreases the value of the marginal unit of advances to 
nature. This latter it could not do unless it respectively 
decreased or increased the supply of advances to nature, 



INTEREST AS A PRICE 



59 



and certainly it does not affect that supply in the small- 
est degree. 

Making an advance to nature, on the other hand, does 
affect the price of such advances, and through them the 
price of advances to persons. For making an advance 
to nature increases the supply of such advances and 
therefore decreases the value of the marginal unit of that 
supply. 

Making an advance to nature locks up, as it were, in 
the storehouse of nature's causal nexus, services to a 
nominal value greater than that of those forthcoming 
therefrom before the lapse of a considerable time ; 
whereas making an advance to a person does not lock up 
services at all, but only transfers from the lender to the 
borrower the title to their disposal — - they being meas- 
ured, for the purpose of the transaction, in terms of nomi- 
nal value — for the time covered by the loan. Advances 
to nature might therefore conceivably have, if supplied 
in inconveniently large amounts, a market cost, which 
might rise with each further advance so as at some point 
to balance any value that further advances to nature 
might have, thus checking the making of further such 
advances and establishing a normal price of advances 
to nature, which would be also the normal price of ad- 
vances to persons. Advances to persons, on the other 
hand, giving to borrowers, as they do, the disposal of ser- 
vices precisely the same in nominal value as those whose 
disposal for the same time they take from the lenders, 
cannot conceivably be affected in cost by their own 
indefinite increase in amounts. The amount of their 
supply, therefore, has no significance whatever in respect 



6o A THEORY OF INTEREST 

to their price. And so we come back again to the asser- 
tions made in § 32 that advances to persons are not to 
be laid off along the base-line, LI, of the price diagram, 
their price being determined by the supply of advances 
to nature, of which, indeed, as I have said, they may be 
regarded, unless we find evidence to the contrary, as 
simply sales. 

§ 36. We need not repeat in respect to advances to 
nature the reasons, given in the fourth paragraph of § 14, 
the second of § 15, the second of § 18, and the seventh of 
§ 25, why costs and values to a market must correspond 
to costs and values to any person in touch with that 
market, and why therefore a diagram representing the 
costs and the values of advances to nature, on the suppo- 
sition of the increase of the supply of such advances by 
successive increments, will serve indifferently for the 
market in such advances or for any person in touch with 
it : these reasons hold for the theory of the price of ad- 
vances to nature precisely as for that of the price of 
goods or services. We are therefore ready to plan at 
once the construction of the diagram representing 
graphically the theory of the normal price of advances 
to nature. In this planning we must proceed slowly, 
for if we are to be sure of every step we must halt often 
for necessary definitions and precautions. 

Along a base-line LI ^ lay off successive units of the 
things of value in question, namely the advances to 
nature existing in connection with the market (for ad- 
vances to nature) in question. This market we may 
think of as that of the whole commercial world. Along 

1 See Diagram II, below (§41). 



INTEREST AS A PRICE 6i 

LK, perpendicular to LI, lay off successive units of both 
the subjective factor of the value of such advances and 
the subjective factor of their cost. This is assuming, 
of course — what has already been assumed several 
times in the last few pages — that advances to nature 
may have both a value and a cost. These points must 
now be fully estabhshed. 

§ 37. Advances to nature may have a value, both a 
personal value and a market value. ^ They have a value 
if locking up in the storehouse of nature's causal nexus 
services greater in nominal value than those for a con- 
siderable time forthcoming from that nexus on that 
account results, after the lapse of enough time, in the 
receiving back of services exceeding in nominal value 
those locked up ; for if it results thus, the excess in nomi- 
nal value of the services received back after ''enough 
time" is the market value of that advance to nature 
whose time-dimension is the time elapsed and whose 
cross-section of nominal value (see § 30) is that of the 
services locked up at the earlier time and also that, less 
the excess, of the services received back at the later 
time. And locking services up in the storehouse of na- 
ture's causal nexus certainly does often result thus. It 
does so in the case of the building of any railway that 
under normal conditions earns, net above all expenses 
of running it, more than enough to repay its original cost. 
It does so in the case of the making of any durable good 

^ They may, indeed, have also a nominal value, as will appear from 
a consideration of two advances to nature separated in time; but the 
analysis of this point need not now turn us aside from our main argu- 
ment. 



62 A THEORY OF INTEREST 

— that is, any good whose immediate services do not pay 
for its making — whose services eventually sell, under 
normal conditions, for more than enough to pay all costs 
of making it and of keeping it in good condition and re- 
pair up to that time. It does so, indeed, in the case of 
the making of anything, or of the affecting of any rela- 
tion between things, which, though not worth while for 
its immediate returns, is worth while for its eventual 
returns — worth-whileness being determined always on 
a nominal value basis. Was it worth while to build the 
Brooklyn Bridge ? Certainly not for the pleasure each 
stroke on it could return immediately, before the lapse 
of any considerable time. The building of it was there- 
fore undoubtedly a locking up of services in the store- 
house of nature's causal nexus, whether it was worth 
while or not. Next, was it worth while on the basis of 
a gain in nominal value? The answer can be inferred 
from the fact that if it had not promised to be worth 
while on that basis, it would have been economically 
senseless. Nothing that we call a tool, a machine, or 
a durable consumption good normally renders services 
that cancel its cost until considerable time has elapsed. 
It is therefore permissible to say sweepingly that never, 
under normal conditions, can it be rational to make a 
tool, amachine, a house, a doll, or any other durable good 
unless the locking up of services in it promises an eventual 
surplus of nominal value. Thus that vast aggregate of 
advantage received by mankind on account of their 
making and possessing the tools, machines, houses, toys, 
and other durable goods that they have made, is simply 
the aggregate of the surplus nominal values due to the 



INTEREST AS A PRICE 63 

advances to nature embodied in the total supply of such 
things. 

§ 38. It is convenient to have a brief name for goods, 
including not only namable things but any relations be- 
tween things, in which advances to nature are locked up. 
What name is better for them than natural capital? 
By natural capital I mean anything in which an advance 
to nature is locked up, including notably tools, machines, 
and durable consumption goods — from carriages to jump- 
ing-jacks — but not excluding less discrete and namable 
things that may embody advances to nature. An ex- 
ample of these latter things is furnished in the case of the 
advances to nature made by the researches of a scientist. 
The labors of a Pasteur or a Helmholtz, of an Edison or 
a Burbank, are certainly advances to nature, except in 
so far as they may be repaid immediately by the pleasure 
of the work itself ; yet they do not always embody them- 
selves in discrete and namable objects. Other examples 
are furnished in the cases of the advances to nature made 
in moving a barrel of apples from Ontario to London — 
from where it is needed less to where it is needed more 
— or in developing mutual regard and esprit de corps 
among the employees of a factory with a view to increas- 
ing its production without increasing the pain of the 
employees' labor. In all these cases the services ad- 
vanced are locked up in the nexus of natural laws even 
though not embodied in discrete and namable objects ; 
and their embodiments are all to be included under the 
term natural capital. 

In connection with this definition of natural capital 
one limitation must be made. Not only does the term, 



64 A THEORY OF INTEREST 

as I use it, exclude things, such as rivers, natural harbors, 
and the gifts of nature generally, whose valuable services 
are clearly independent of the previous investment in 
them of human labor, the previous embodiment in 
them of advances to nature, but it excludes even such 
of the embodiments of advances to nature as do not 
owe those advances to identifiable persons moved by 
economic motives. It excludes, for example, those 
groupings of population and of social institutions which 
result in the great services (of urban land-sites) that we 
buy at their market price when we pay high urban land- 
rents. Such groupings are not direct gifts of nature 
but embodiments of the political and social labors of 
men, and therefore they constitute what might not un- 
reasonably be regarded as a kind of capital ; yet the dis- 
tinction between them and the capital in which men 
embody advances to nature with the conscious intention 
of enjoying both principal and interest later — this 
distinction, I say, is so important for the light it throws 
on the justice or injustice of certain social institutions 
that such groupings had better not be included under 
the term natural capital. They will be treated further 
and given a suitable name in § io6 of Chapter VIII. 

§ 39. To return now to the main Kne of our thought, 
advances to nature may have cost, both personal cost 
and market cost. This is not denying, of course, that 
some advances to nature may be made without cost. 
If your provision, relatively to your wants, is greater 
this year than it will be next year, you can certainly 
make some advances to nature without cost. (This 
corresponds to the principle, in the theory of the 



INTEREST AS A PRICE 65 

normal price of goods or services, that some persons 
under some circumstances may be able to raise a few 
apples or play a few sonatas without cost.) But if, 
after the making of all the advances to nature thus 
made without cost, it is found that an additional 
advance^ would have value — not value above cost, of 
course, but value simply — economically rational per- 
sons are impelled to make the additional advance at any 
necessary cost to them less in their estimation than the 
value to them it will have. And so, normally, rational 
persons will go on making more and more advances at 
ever increasing cost until they reach the point of normal 
equilibrium where the value to them of a further ad- 
vance would not in their estimation exceed its cost to 
them. Indeed, it is only the (estimated ^) cost of further 
advances that can account for the fact that every person 
in touch with the market fails to make certain further 
advances that he does fail to make. For every such 
person certainly ceases making advances before he has 
advanced the last unit of his income or his vital force ; 
certainly, too, every such person could get at least 2 % 
interest — that is, surplus nominal value amounting in 
a year to two hundredths of the nominal value of the 
principal, and that without appreciable danger of losing 
the principal — by making the first of the advances he 
fails to make ; and therefore nothing but the (estimated) 
cost of that first one of his unmade advances can account 

1 Here, as elsewhere, it is important for the reader not to confuse in 
his mind an advance with the goods or services advanced. 

2 For the significance of this word see the fifth paragraph of § 41 
below. 



66 A THEORY OF INTEREST 

for any such person's discontinuing to make advances at 
the point where he does discontinue. 

As it is now clear that advances to nature do in some 
cases have value and do in some cases have cost, we may 
continue the planning, undertaken in § 36, of our dia- 
gram to illustrate the theory of the normal price of ad- 
vances to nature. 

§ 40. Note well just which advances to nature are to 
be laid off along the base-line, LI. They must include 
all those that actually constitute the world-market's 
supply, but they must not include any others. They 
must not include, for example, advances existing pre- 
viously but not existing at the time in question, w^hich for 
convenience may be assumed to be the present. This 
excludes advances once embodied in certain old walls, 
for example, stone arrow-heads, and what-not, that exist 
still but can no longer be said to embody advances be- 
cause they are no longer useful and therefore no longer 
kept in their old embodiments purposely. They must 
not include, furthermore, advances conceived as em- 
bodied in the natural capital men would invest in if they 
were perfect in knowledge and skill, or if any conditions 
were in any way other than they are. This requires a 
little explanation. Nature offers men, as we have seen, 
opportunities to lock up services in natural capital whose 
services in turn, after the lapse of more or less time, will 
have a nominal value in excess of that of the services 
locked up. But in their capacity for taking advantage 
of these opportunities men are restricted by the limita- 
tions of the knowledge possessed by scientists, by those 
of the diffusion of that knowledge among the people 



INTEREST AS A PRICE 67 

generally, and by those of the industrial skill and the 
capacity for taking pains, on the part of laborers, requi- 
site for using certain conceivable sorts of natural capital 
— complicated machines, for instance — to the best ad- 
vantage. Thus the series of advances to nature laid off 
along the line LI, which is to represent the actual supply 
at the time in question, lacks nobody knows how many or 
what advances to nature that are conceivable, and that 
may sometime through a change of conditions come into 
existence, but that are not in existence because not un- 
derstood or because uneconomical under the conditions 
of the time in question. The series of such advances 
existing at present (a.d. 19 13), for example, lacks those 
that might conceivably be embodied in certain physically 
possible but as yet uninvented improvements of the aero- 
plane, those that might conceivably be embodied in ad- 
ditional specimens of an improvement of the aeroplane 
already invented but not yet understood by all airmen 
who could adopt it with advantage if they did under- 
stand it, and those that might conceivably be embodied 
in additional reaping machines, of a model already used 
to advantage by thousands of farmers, which would have 
been manufactured if the ignorance, stupidity, or shift- 
lessness of certain other farmers or their hired laborers 
had not prevented their being able to use such machines 
to advantage and their demanding them in the market. 

The order in which the advances to nature laid off 
along LI are to be arranged is, of course, that of the 
market value they would have, under the actual condi- 
tions of scientific knowledge, general education, skill, etc., 
if they were marginal. Next to L, in other words, must 



68 A THEORY OF INTEREST 

stand the advance to nature embodied in whatever 
natural capital society could least afford, under actual 
conditions, to be deprived of. Next to that first one must 
stand the advance to nature embodied in whatever natu- 
ral capital society could next least afford to be deprived 
of. And so on through the whole series of existing ad- 
vances to nature. Very high in the series of the present 
time must stand some of the advances embodied in iron 
foundries and steel plants, some of those embodied in 
printing presses, some of those embodied in the main 
railway lines, and some of those embodied in well-bred 
stocks of domestic animals. Lower in the series must 
stand additional units of advances embodied in natural 
capital of these same kinds and also the first units of 
advances embodied in natural capital of less important 
kinds. Lowest of all in the series must stand advances 
embodied in that natural capital which under normal 
conditions men would sacrifice first if they had to sacri- 
fice part of their present supply. 

§ 41. When the units of the actual supply of advances 
to nature are arranged thus along the base-line, the 
market value of any unit, on the supposition that it is 
the marginal or last unit of the supply, is represented by 
the length of a line perpendicular to the base-line from 
the position of the unit on the base-line to its intersec- 
tion with such a curve as OR. 

Now consider how we may represent the cost of the 
units of advances to nature laid off along LI. The unit 
which, if marginal, would have the highest value, that is, 
the unit we have placed nearest to L on LI, would have 
least cost, or — if we suppose that a few units, between L 



INTEREST AS A PRICE 



69 



and S, would have no cost at all — would be farthest 
below the cost Hne. The unit which, if marginal, would 
stand second in value, that is, the unit we have placed 
next nearest to L on LI, would have the next higher 
cost or stand next higher towards the line where cost 
would begin. And so on : when the units of advances are 
arranged in the order of their descending values — to the 
advancer or to the market of any specified time — if 

K 




Diagram II 



each were marginal, they must be arranged — normal 
conditions being assumed throughout — in the order of 
ascending costs. This is confirmed by a moment's re- 
flection. For a man to advance for a year the first 
dollar of his yearly income, which, of all the dollars he 
may advance, is the one whose advance will normally be 
most valuable either to himself or to the market, requires 
his sacrificing the enjoyment now of those services a 
dollar will now buy that he is most wilhng to sacrifice 
now, in order to have the enjoyment next year of those 
services a dollar will then buy that he will be most wilHng 
to sacrifice then. (The surplus services which the three 



70 A THEORY OF INTEREST 

or four cents he may receive as interest will buy next 
year do not concern us in respect to the mere cost of the 
advance : they concern us only in respect to its value.) 
For the same man to advance for a year the thousandth 
dollar of his yearly income, that is, one dollar of a thou- 
sand advanced, affects him very differently : the thou- 
sandth dollar, which is applicable normally, as we have 
seen, to a less valuable advance than the first dollar, re- 
quires the advancer to sacrifice the enjoyment now of 
services a dollar will now buy standing a thousand points, 
so to speak, higher on his list of services arranged accord- 
ing to his preferences, in order to have the enjoyment next 
year of services a dollar will then buy standing a thousand 
points lower on his list. Clearly, whatever may be the 
cost — to any person or group of persons, however rich 
or however poor — of advancing for any time any speci- 
fied unit of income, the cost of advancing for the same 
time the next additional unit must be greater. 

The normal market cost, then, of any unit of the exist- 
ing advances to nature laid off along LI is represented by 
the length of a line, perpendicular to LI, from the posi- 
tion of the unit on LI up to such a curve as CH, which is 
drawn so as to bound the cost lines of all the units. The 
costlessness that may characterize some few units nearest 
to L (see § 39) is indicated in the diagram by drawing 
CH below LI until it reaches a point, S, somewhat to 
the right of L. 

In explaining the two curves, OR and CH, I have 
spoken only of market value and market cost respec- 
tively. I do not mean to imply, however, that the same 
curves would not represent equally well the boundary of 



INTEREST AS A PRICE 71 

the lines of the value and the cost of the different units to 
any particular person. They would do so, for reasons ex- 
plained in § 14 (1l4),§ 15 (^2),§ 18 (1l2),and§ 25 (^[7), 
and referred to in the first paragraph of § 36 : the whole 
diagram represents consistently either values and costs 
from the market's point of view or values and costs from 
the point of view of any person in touch with the market. 
The reason why I neglect sometimes the personal point 
of view is that the goal of this part of our inquiry is an 
understanding of the normal price of advances to nature, 
to which price, of course, the market values and the 
market costs of the units of such advances are more 
closely related, in our thinking, than are their personal 
values or their personal costs. 

If now we make one slight change in the definition of 
these curves, we shall be free to complete our diagram 
for advances to nature as we did that for goods and ser- 
vices, by dropping from the point of intersection of the 
two curves a perpendicular to LI which will represent 
the normal price of such advances. The two curves of 
significance to us, those the perpendicular from whose 
intersection will represent the normal price of advances, 
are not precisely those we have described, those bounding 
the lines of value and cost, but those bounding the lines 
of estimated value and estimated cost. For of course it is 
not necessarily where the value to him of advancing 
another unit actually fails to exceed the cost to him of 
advancing it that any advancer normally ^ ceases making 
advances : it is where it fails to do so in his estimation. 
The normal value to any person of a unit of advances 

^ See the third paragraph of § 18. 



72 A THEORY OF INTEREST 

will be determined by the point of intersection of his 
curves of estimated value and estimated cost instead of 
by the point of intersection of his curves of value-in-fact 
and cost-in-fact. This possible error of estimation, by the 
way, is the one excepted cause, preventing "men's acting 
according to their best economic interests," to which I 
referred when defining the word normal in the third 
paragraph of § i8 : in respect to advances I call condi- 
tions normal when men are prevented from acting ac- 
cording to their best economic interests by nothing except 
this error of estimation. 

If the curves of our diagram are reinterpreted thus as 
indicating estimated values and estimated costs instead 
of actual values and actual costs — to the market, of 
course, as well as to the person — it becomes correct to 
say that the height above the base-line of their point of 
intersection represents the normal market value or the 
normal price of a unit of advances to nature. 

§ 42. "The height above the base-line," I say. Is it, 
then, inevitable that the intersection of the curves will 
be above the base-line ? Is it inevitable, in other words, 
that the line WV, representing the normal price of a unit 
of advances to nature, will have positive length? The 
question is crucial, for the price of advances to nature, 
per unit, is nothing else, as we shall soon see, than the 
rate of natural interest. The answer is in the affirmative : 
the line WV must normally have positive length; the price 
of advances to nature^ per unit, or the rate of natural interest, 
must normally he above zero. Evidence of the truth of 
this, to be interpreted now in accordance with the modi- 
fication about the error of estimation in the fifth para- 



INTEREST AS A PRICE rf 73 

graph of § 41, was given in § 39. It is not conceivable 
that everybody would cease making advances to nature 
at a point where, with no appreciable danger of losing 
the principal, they could still get "2% interest" by 
making more advances unless a further advance would 
have for them positive cost ; for certainly services which 
the "2% interest" obtainable by making the further 
advance would buy would have for them positive value. 

This evidence for the inevitability of a positive rate of 
interest is, I say, sound. I do not say, however, that, by 
itself, it is thoroughly convincing. It will scarcely 
change the views of readers who felt sure, before reading 
this book, that a positive rate of interest is by no means 
inevitable but the result of certain social institutions, 
legal, political, and industrial. Such readers are sceptical 
of all evidence that conflicts with their preconceived 
opinions and will not accept it unless the analysis goes 
deep enough to show them not only that there is such 
evidence but why there must be. 

§ 43. I propose to carry the analysis deep enough now 
to convince the most sceptical that a positive rate of 
interest is inevitable. To do this most conveniently 
I must represent the factors involved by the symbols 
of algebra instead of by those of geometry. 

Suppose the services advanced are designated a and 
the subjective factor of value, on the part of the market, 
cooperating with a is designated h. Then the market 
value of those services at the time they are ad- 
vanced is ah. In accordance with the definition of 
the principal that conforms to the conception of it uni- 
versally held — see 1[ 4 of § 8, § 14, and § 30 — the 



74 A THEORY OF INTEREST 

principal of the later time must be services equal to ab 
in nominal value. If, therefore, we designate the ser- 
vices themselves that constitute the principal of the later 
time as a', and the subjective factor of value of the 
market of that time as b\ the definition of the principal 
is expressed by the equation 

ab = a'b\ 

Now let us make an algebraic equation of the equahty 
of the estimated cost and the estimated value, to any 
advancer at the margin of his advancing, of an additional 
increment of advances to nature. (That this equality 
must exist at the margin of any advancer is clear from 
the sixth sentence of § 39 and the fifth and sixth of the 
second paragraph of § 25.) If we represent his subjec- 
tive factor of value at the earlier time by b^^ and his 
subjective factor of value at the later time by b'^\ the 
estimated cost to him of the supposed additional advance 
must be any difference there may be between ab'^ and 
a'b^'' ; that is, it must be ab'^ — a'b'". As for the esti- 
mated value of the advance to him, that we can express 
by the product of b"\ his subjective factor of value at 
the later time, and a symbol, say a'\ representing the 
objective factor of that value, that is, the concrete ser- 
vices he may conceivably receive, over and above those 
constituting the principal, on accoitnt of having made 
the advance to nature in question. Then the equality 
of the estimated cost and the estimated value of an 
additional advance, to any advancer at his margin, is 
expressed by the equation, 

ab^' - a'b'^' = a'^b'^'. 



INTEREST AS A PRICE 75 

Take now the fact, proved true but unaccounted for 
in § 39 and § 42, that both the estimated cost and the 
estimated value, to any advancer, of an advance at his 
margin must be positive. That fact may be expressed 
algebraically thus : 

or a'^h'" > o. 

We now have before us in convenient algebraic form 
the data necessary really to solve the problem of interest. 
The data consist of the three principles : 

(i) ab = a'h' 

(2) ah" - a'h'" = a"h"' 

(3) a"h"\ox ah" - a'h'") > o. 

From these propositions we may derive a fourth, namely, 

(4) h^h 
h'" ^ h' 

§ 44. In the meaning of these four propositions are 
to be discovered the reasons why a"h"' must be greater 
than zero, the reasons why interest persists age after age, 
and also the causes that determine the normal rate of 
interest. Let us consider the four principles, one at a 
time. 

The first is merely the algebraic expression of the defini- 
tion I gave to the "principal" of an advance. But remem- 
ber that that definition was not arbitrary : it conformed 

* For the benefit of readers not familiar with the signs used in alge- 
bra I will say that this sign means is greater than. The whole expres- 
sion means, then, simply that the excess of ah" over a' h'" is greater 
than o. 



76 A THEORY OF INTEREST 

to the conception which every reader will admit, I think, 
that he himself holds. And it is profoundly significant 
for the theory of interest. For it is not too much to say 
that if men conceived the services of different times that 
are to be regarded as the unit of an advance, that is, 
if they conceived the principal, in terms of equality to 
the advancer instead of in terms of equahty to the market 
of the passing time, that is, if they conceived it in terms of 
equahty in value to the advancer instead of in terms of 
equality in nominal value, the phenomenon we know as 
interest would not appear at all. The services of the 
later time that are equal to the services a in estimated 
value to the advancer are the services a' + a" . Sup- 
pose, then, that a' -j- a" were regarded as the principal 
of the later time. In that case no surplus services called 
interest would have to be thrown in to boot with those 
in that case regarded as the principal of the later time, 
to establish that equality between the cost and the value 
of the advance to the advancer which must normally 
exist at the margin of any advancer ; and indeed not so 
much as the conception of the surplus called interest 
would ever enter anybody's mind. Now adopt again 
that conception of the principal which is actually held 
by men, that of services constant in nominal value, that 
is, constant in value to the market of the kaleidoscopic 
society that changes with each moment of the passing 
time. Once that conception of the principal is held 
again, the surplus again emerges ; for with that concep- 
tion, as we have seen, though for reasons not quite yet 
explained, a"h"' must be greater than zero, — which 
means that the advancer must receive certain services, 



INTEREST AS A PRICE 77 

a'\ over and above the services a' that constitute the 
principal of the later time. 

The second of our four propositions is bound up with 
the first one by being expressed in terms whose mathe- 
matical values are determined by the first one. In 
other words the a and a' of the second proposition stand 
for two lots of services which happen to be equal in nomi- 
nal value, according to the equation ah = a'h' ; and the 
a" of the second proposition stands for a lot of services 
that has to be added to the lot a' to make a lot, a' -f a" ^ 
equal, in estimated value to the advancer at his margin 
of advancing, to the lot a. 

The third proposition, which is also expressed in terms 
of a^ a\ and a" ^ is based partly on the second proposition 
and partly on the first paragraph of § 42. It expresses 
the fact that at the margin of advancing of any advancer, 
an advance, defined as to principal as it always is, must 
have positive value to him and positive cost to him. 

The fourth proposition was derived, as I have said, 
from the other three. I now ask the reader's attention 
to its meaning. It is to be recalled that h'" stands for 
the estimated subjective factor of value of the advancer 
in connection with services of the later time, that h" 
stands for his subjective factor of value in connection 
with services of the earher time, that h' stands for the 
changing society's or market's estimated subjective fac- 
tor in connection with services of the later time, and that 
h stands for the changing society's or market's subjective 
factor in connection with services of the earher time. 
Expressed in language, then, the fourth proposition 
means that with the passing of time the subjective factor 



78 A THEORY OF INTEREST 

of any advancer must in his estimation decline relatively to 
that of the changing society. 

§ 45. This proposition, which we have derived by 
algebraic processes from three others that were them- 
selves based on somewhat extended argument, can for- 
tunately be confirmed directly by common sense. The 
h" and h'" of the fourth proposition stand, remember, for 
the advancer's present subjective factor and estimated 
future subjective factor respectively, and the h and the 
h' for the changing society's present subjective factor 
and estimated future subjective factor respectively. 
The meaning, then — to repeat the point — of the prop- 

h" h 
osition expressed algebraically by the inequality — ^, > — 

must be that with the passing of time the subjective 
factor of any advancer must in his estimation decline 
relatively to that of the changing society. Well, then, 
the question now before us is whether that can be shown 
to be true by evidence wholly independent of the reason- 
ing by which we arrived at the algebraic expression 
of it ? It can. It must be true if causes exist that would 
be sure to produce it as their effect. And such causes 
do exist. What would such causes be ? Obviously any 
conditions that would generally be expected to affect 
the advancer's subjective factor with the passing of time, 
in the direction of reducing it, without affecting the chang- 
ing society's subjective factor in the same way to the 
same extent. Now at last we are driving our quarry to 
its last hiding place : we see now that if there are condi- 
tions that may be expected to make the advancer's sub- 
jective factor of value decline with the passing of time, 



INTEREST AS A PRICE 79 

relatively to that of the changing society, those condi- 

tions may account for the fact that -— is greater than 

— and therefore for the persistence of the nominal surplus 

a'^ as a positive quantity of services. Are there, then, 
such conditions ? Yes, there are : aside from the con- 
ditions connected with the passing of time that may affect 
both the advancer's subjective factor and the changing 
society's equally, there are some involved in the ad- 
vancer's aging and death that affect the advancer's sub- 
jective factor, in the direction of reducing it, without 
affecting the changing society's at all. Is not the chang- 
ing society expected to live on indefinitely ? And is not 
the advancer — whether one person, or a hundred, or 
all the. persons of a specified time's market — expected 
to grow old and die ? 

This explanation may be defended under two headings. 

First, the certainty of the advancer's own death within 
a few decades — whether the advancer be a person, a 
married couple, or any other group of individuals — 
and the chance of his death within any period, however 

short, makes —7 less, quite apart from any error of esti- 
h 

7 r 

mate, than — . For it lowers h'" relatively to h'^ without 

h 
correspondingly lowering h' relatively to h. It lowers 

h'" relatively to h^' because death removes altogether 

the advancer's own subjective factor for the later time 

and does not supplant it with any subjective factor 

virtually his own of equal magnitude. By ''subjective 

factor virtually his own" I mean that of heirs he may 



8o A THEORY OF INTEREST 

have whose pleasure he may regard, at the time of the 
proposed advance in question, as in a sense his own. 
Not every person, of course, has heirs for whom he has 
such feehngs. And even in the case of those who do 
have them, the heirs' subjective factor equals that of 
the advancer in magnitude only for services advanced 
for the benefit of the heirs up to a certain point, namely 
the point where another unit of services advanced would 
mean less pleasure to the heirs at the later time than 
services objectively the same would mean to the advancer 
at the earlier time. How soon that point must be 
reached is realized when we consider that each new 
generation has fresh powers of production and of acquisi- 
tion as well as fresh wants. 

Take, for example, the healthy, nearly grown, and 
fairly well educated children of an artisan whose income, 
derived from his labor only, is fifteen dollars a week. 
Even in the case of the fifteenth dollar per week, the 
subjective factor of such children several years hence is 
probably lower than that of the artisan and his wife 
themselves now. It is, indeed, only in the case of heirs 
very young at the later time in question and parents 
well off at the earlier time in question that the future 
subjective factor of the heirs, even supposing the pleasure 
of the heirs to be regarded by the parents as virtually 
their own, can reasonably be reckoned by the parents as 
fully supplanting their own present subjective factor in 
connection with any services they think of advancing. 

In passing I will draw attention to the fact that this 
weighing of the subjective factor of heirs against that of 
the advancer involves the comparison of absolute amounts 



INTEREST AS A PRICE 8 1 

of pleasure, which, as explained in § 19, cannot be meas- 
ured exactly. 

Secondly, the error of estimation will not be denied, 

in the case of most advancers, to increase the difference, 

7/// 7/ 

for any period of time, between—- and — . On this 



point I will not enlarge here : it is familiar to all students 
of economics and is discussed in §§' 68 and 79. 

We have seen that the bearing on the three previous 
propositions of the fourth, whose truth is thus confirmed 
by common sense directly, is that of an equation derived 
from those three by the processes of algebra. But con- 
sider what must be its true logical relation to those 
three. Though formulated by us later than the third 
proposition, the fourth is really the expression of the 
conditions that are the causes — in cooperation, of 
course, with the conditions expressed by the first equa- 
tion and the second — of the results covered by the 
third. It is because the subjective factor of any ad- 
vancer must decline, with the passing of time, relatively 
to that of the changing society, that the margin of any 
advancer, the point where a further advance seems to 
offer him no advantage on the whole, is reached while 
a''h"' (as also ah" — a'h'") is still greater than zero. 
All the factors and relations involved in the interest 
problem are therefore covered by the three propositions 

(i) ah = a'h' 

(2) ah" - a'h'" = a"h'" 

. . h" h 
(4) ^>^-,- 



82 A THEORY OF INTEREST 

As proposition (3) of § 43 adds nothing to these three, 
it may, for most purposes of our analysis, be dropped 
from the Kst. 

§ 46. The elusive secrets of the interest problem, 
though expressible so simply in algebraic terms, and 
though expressible clearly also, as I shall show in Chapter 
V, in geometrical terms, are hard to express either simply 
or clearly in language. To the expression of so many 
factors and relations language is comparatively ill 
adapted. I must try, however, to explain the enigma 
of interest in language as well as in the other 
media. 

§ 47. Natural interest is the price of an advance to 
nature (in the case of an isolated advancer, a Crusoe, 
not the price but services equal to the advance in value to 
the Crusoe — see the third paragraph of § 34 and § 51), 
in other words the services of the later time for which the 
advance will exchange, the kind and quantity of these ser- 
vices being measured in terms of nominal value and the 
advance itself being defined as the exchange of services of 
the earlier time for those of the later time to the same nominal 
value. Natural interest is usually measured in terms of 
a rate or ratio, whose denominator is the nominal value 
of either of the two lots of services whose exchange con- 
stitutes the advance to nature and either of which is 
called the principal, and whose numerator is the nominal 
value, or value to the later time's market, of the services 
of the later time for which the advance to nature ^ will 
exchange. What puzzles people who reflect about in- 

^ Here again it is perhaps necessary to caution the reader that an 
"advance to nature" is not to be confused with the services advanced. 



INTEREST AS A PRICE 83 

terest is why an advance to nature should persist in 
commanding any price at all above zero. " With every- 
thing except advances," people say, "the price corre- 
sponds to the value to the producer ; and that falls, 
under normal conditions, to equality with the cost to 
the producer. Why should not the same hold true of 
the price of advances to nature ? And if it does hold 
true of them, why should not the price of such advances 
fall to zero, an advance being nothing but the exchange 
of services of one time for services of a later time to the 
same value ?" 

We are now in a position to see how this difhculty 
arises. An advance to nature is, indeed, "nothing but 
the exchange of services of one time for services of a 
later time to the same value." But to the same value 
to whom? It is only when we ask that question, answer 
it right, and analyze all that the answer involves, that 
we are in the way of solving the problem. The services 
of the later time are of the same value as those of the 
earlier time to the kaleidoscopic procession we call the 
changing society. The definition of the principal on this 
basis has been defended in §§ 14, 30, and 34 (1[ 3) ; now 
we must analyze its significance. It fixes at once the 
services of the later time (the services a') which are to 
be considered the later principal as services having a 

nh 

nominal value equal to 77-, and therefore as objectively 

less, that is, less in quantity or of a kind standing lower 
in the series explained in § 40 (T[ 2), than those services 
of the later time that are equal to the services advanced 
in estimated value to the advancer at his margin. Why ? 



84 A THEORY OF INTEREST 

Because it fixes a! as equal to a multiplied by 77, whereas 

the services of the later time that are equal to the services 
advanced in estimated value to the advancer at his 

h" 

margin must be a multiplied by 7777, a ratio that we know 

to be larger than 77 according to the fourth proposition 

of § 43. The effect of this is to make an advance, 
defined as it is in respect to principal, cost any advancer, 
at his margin and in his estimation, just the difference 
between the estimated value to him of the later services 
a' and the estimated value to him of the objectively 
greater lot of services necessary to be equal to the services 
a in estimated value to him. So an advance, defined as 
it is, does have an estimated cost above zero to any 
advancer at his margin; and any advancer will cease 
making advances at the point where this estimated cost 
to him of an advance as thus defined equals the estimated 
value to him of an advance as thus defined, in other 
words where he can get in exchange for the services a 
of the earlier time not only services of the later time of 
the kind and amount a' but also additional services of 
that time, a'\ of such kind and amount as to make 
{a! + a")h'" equal to ah" or — what is the same thing 
— to make a"h"' equal to ah" — a'h'". And so, since 
the advancer is the only possible producer or supplier 
of advances to nature, his cessation of advancing at that 
point must make the lot of later services, a" , which is 
additional to the lot a' and therefore called a surplus in 
spite of the fact that it is not a surplus at all from the 



INTEREST AS A PRICE 85 

point of view of the advancer at his margin, persist age 

after age as a positive quantity of services. Finally, so 

long as the objective surplus services a" persist, so long 

their (estimated) value to the society of their time, a"h\ 

by which men measure the price of the advance, which 

is interest, must persist as a positive quantity; and so 

long the ratio of a"})' to the nominal value {ah or a'h'^ 

of the principal {a and a') must persist as a positive 

a"h' 
quantity. And that ratio, - — 7-, as was explained in the 

second paragraph of this section, is the rate of in- 
terest. 

§ 48. Since a' and a" are determined, relatively to a, 
by the subjective factors, &, h\ h" ^ and h'" ^ it is possible 
to deduce from the three propositions of § 45 formulae 
for the amount of natural interest and the rate of natural 
interest that contain only one objective factor. These 
formulae are derived from the three propositions of § 45, 
of course, by the ordinary processes of elementary algebra. 
They are as follows : — 

a"h\ the measure in terms of nominal value of the 

interest^ must always be ah f — — ~ ^ ) 

a"h' . h'h" 
, the rate of interest, must always be — — — i . 

ah hh 

And from these two propositions it follows that when ah 
is 100, as it is in the case of an advance to nature such 
as would be represented by Figure II of § 30, the con- 

Vh" 



Crete interest, which would then be 100 (77777— ^ J' must 
be also the rate of interest per cent. In other words the 



S6 A THEORY OF INTEREST 

rate of interest per cent ^ must be 

§ 49. Discount is merely interest from a different 
point of view. When we speak from the point of view 
of the principal of an advance — for instance from that, 
in our example, of the 8 suits in 191 2, the 9 suits in 1913, 
or the $100 at either time — we use the word interest: 
''A loan," we say, ''of $1000 should now yield $50 a 
year interest." When, on the other hand, we speak from 
the point of view of the principal plus the interest — 
both of the later time in question — we use the word 
discount: "$1000 due a year hence," we say, "can 
be bought at a discount now for $952.38^." In this 
latter case the principal of the advance in question is 
$952.38^, and the interest on that principal is $47,619^. 
What we have in mind, however, in this case, is not the 
principal but the principal plus the interest, both of the 
later time, that is, the $1000 of next year that is to be 
" discounted." 

In terms of the case represented by Diagram III of 
§ 52, the interest was iVo of ^ suit of clothes (see If 2 of 
§ 30), or yf 0" of the principal of the later time, or j^-q 
of $100, or $3.^ The conditions of the market for ad- 

^By "rate of interest per cent" I mean the "6" of the expression 
'*6%," the "4" of the expression "4%," etc. In the case considered, 

then, 100 (lTir,-A is 3, not jfo or 3%- 

2 This may puzzle the reader if he forgets that each suit is worth at 
the later time, according to our supposition, $11^. — If one suit is worth 
$11 1, then xVo of ^ suit is worth $3. 



INTEREST AS A PRICE 87 

varices remaining the same, the discount on the 9iVo 
suits of 1 91 3 (equivalent to $103), to be delivered in 
1 9 13 but to be paid for in 191 2, would be yVo of ^ suit 
in 1913 (equivalent to $3), the principal advanced in 
that case being 8 suits in 191 2 and 9 suits in 191 3 (either 
lot equivalent to $100) ; and the discount on 9 suits 
in 1 913 (equivalent to $100), to be delivered in 1913 but 
to be paid for in 191 2, would be yoV of ^ suit in 1913 
(equivalent to $2^0*3), the principal advanced in that 
case being a trifle more than y^-^^ suits in 191 2 and a 
trifle more than 8^0% suits in 191 3 (equivalent to 

$97t!3)- 

§ 50. The first formula for interest in § 48 (namely, 

interest = abi — ~ — i j will serve equally well for dis- 



count, of course ; but in applying it one must not for- 
get that the symbol a in it means the services of the 
earlier time which are the principal of the loan, and 
that it does not mean the services of the later time, 
principal and interest together, which are being " dis- 
counted." As for the second and third formulas of § 48, 
namely that for the rate of interest and that for the 
rate of interest per cent, they also would serve for dis- 
count too if the rate of discount were defined as the 
ratio of the nominal value of the discount to that of 
the principal, not as the ratio of the nominal value of 
the discount to that of the services discounted, which 
comprise principal and interest together. As the con- 
ception of a rate of discount, however, is not common 
or clearly defined among men of business, it is not worth 
while for us to concern ourselves with it further. 



88 A THEORY OF INTEREST 

§ 51. We have now to take account of the case (re- 
ferred to in § 34) of an advance to nature made — if 
such a thing is conceivable — by a person hke Crusoe 
who has no access to any market for services. Such a 
person cannot make an advance to nature of services 
defined as to principal in terms of nominal value, for the 
obvious reason that the services of his world have no 
nominal value at all, that is, no value to the ''changing 
market of the passing time." And yet advances to 
nature are certainly possible to such a person, and ra- 
tional too ; for what but such an advance would be the 
quite rational building of a hut, at a cost in labor much 
greater than would be cancelled by the value of its ser- 
vices until a considerable time had elapsed, provided only 
its services promised to outweigh its cost eventually? 
How, then, are we to define the principal of such an ad- 
vance in Crusoe's case ? 

When Crusoe considers the question of undergoing 
painful labor for the sake of pleasure to follow immedi- 
ately, he is guided to his decision by the same simple prin- 
ciple that guides a man in touch with a market, the prin- 
ciple explained in the fifth paragraph of § 10 and in § 16. 
And when he considers the question of undergoing pain- 
ful labor for the sake of pleasure to follow considerably 
later, he is guided to his decision, again, by the same com- 
parison — that is, of the pleasure dependent on the labor 
with the pain on which the labor depends — which guides 
a man in society. But whereas the man in society con- 
siders to be principal, as distinguished from "surplus" 
or "interest," so much, of the services of the later time 
that he is to get in exchange for those of the earher time, 



INTEREST AS A PRICE 89 

as are equal to those of the earher time in nominal 
value, a Crusoe does not find any part of the later ser- 
vices marked off thus Irom the rest as principal. For 
in his world there is no such equation as ab = a'h' (see 
the second paragraph of § 43) ; and for him the equation 
ah'' - a'h'" = a"b'" of the world of the market be- 
comes ah" — ah'" = a"h"' . As h and h' do not exist in 
his world, the services of the later time in his world that 
correspond to the services a' in the world of the market, 
that is, the services that constitute the principal of the 
later time, are services equal to the services a, when con- 
temporary with a, in value to Crusoe himself ; and the 
formula for the rate of interest with Crusoe becomes 

h" h'h" 

— - I mstead of ^ - i- 



CHAPTER V 

Relations of the Interest Problem Represented 

Geometrically 

§ 52. As I have said, the relations of the many factors 
involved in our problem are hard to explain clearly by 
means of language only. They can be dealt with most 
conveniently in the symbols of algebra, to which there- 
fore I have had recourse. Many minds, however, in- 
cluding my own, are not quite satisfied with their grasp 
of such relations until they have visualized them in terms 
of relations in space. For many of us, therefore, it is 
fortunate that the relations involved in the interest 
problem can be represented geometrically. 

§ 53. It is to be especially noted that the pairs of 
curves which in Diagram III below coincide at G, 0, X, 
E, L, and U are not the same curves we had in Diagram 
II (§ 41), which bound the estimated cost and the esti- 
mated value of the various units of advances (to nature) , 
but those we had in Diagram. I (§ 25), which bound the 
same factor-lines in the case of services. 

In Diagram I we represented the cost or the value of 
any unit of services by a mere hne instead of by an area 
because we assumed the unit of services whose cost or 
value was in question to be infinitesimal in size. In our 
present diagram, however. Diagram III, the marginal 
unit of services considered is in every case one of appre- 

90 



RELATIONS OF THE INTEREST PROBLEM 



91 



ciable size, so that its cost and its value — which are 
equal/ of course, since we are at the margin — will have 
to be represented by an area instead of by a line. 

Since the curves bounding the cost and the value of 
various units of the supply of services coincide theoreti- 

__ Y^ 

Numerical equivalents, according 
to the case used as an example in 
the text, of the lines and rectangles 
of 1912-1913. 




Numerical equivalents of the lines 
and rectangles of 1914. 

a"' = 8i^ a"'b""' = . 

3"" = i2j a""b""' = ^tiih 

a""b"" = z 

'' — 5] 0605 

The capital letters indicate points. The small italics indicate lines corresponding to the 
factors designated by the same symbols in the algebraic sections of Chapter IV. Thus b" 
is the line EC; (5 is the line GC; a is the line IJ, etc. 

Diagram III 

cally at only a single point, as in Diagram I (§ 25), we 
ought theoretically to represent the cost and the value 
of a unit of services of appreciable size by two different 
areas such as the shaded areas of Figure I and Figure II 
below respectively. For the study of our particular 
problem, however, it will do no harm to represent the 

1 Except, of course, for the slight difference suggested in the following 
paragraph. 



92 



A THEORY OF INTEREST 



curves as coinciding in a horizontal line long enough to 
bound the top of the shaded areas representing respec- 
tively the cost and the value of the marginal unit of the 
services in question, so that the area becomes a rectangle. 
The assumption involved in doing this is, of course, 
merely that the cost and the value of the infinitesimal 
unit at the very margin hold true also of all parts of a 
unit of appreciable size. For example, the assumption 
is that in the case of the advance to nature of the ser- 
vices required to produce eight suits of clothes having 
a market price of $12.50 each, the cost and the value 




Figure I 



Figure n 



of the infinitesimal unit of these services at the very 
margin holds true of all the other units of them ; and 
no one will contend that the error of such an assumption 
can lead us astray in respect to the main factors of the 
interest problem. 

The base-Hnes of Diagram* III are those of three suc- 
cessive years, 191 2, 1913, and 1914, as marked. For the 
illustration of the main factors of the problem the part 
of the diagram covering 191 2 and 19 13 is sufficient; 
but the part covering a third year is added to illustrate 
the factors involved in the compounding of interest, 
which we shall consider in § 59 below. 

§ 54. The diagram illustrates the case of the advance 



RELATIONS OF THE INTEREST PROBLEM 93 

to nature involved in locking up in the storehouse of na- 
ture's causal nexus the services required to make eight 
suits of clothes, each having a market value corresponding 
to the price $12.50. It is drawn to scale, each objective 
unit being represented by a sixteenth of an inch laid 
off across the page from left to right, as from C towards 
D or from I towards /, and each subjective unit being 
represented by a sixteenth of an inch laid off up the page, 
as from C towards G or from / towards 0. Of the two 
curves coinciding from E to F, the lower bounds the cost 
to the advancer ^ of successive increments of the ser- 
vices of 191 2, the advance of which is illustrated by the 
diagram covering the two years ; the upper bounds the 
value to him ditto. Of the two curves at G, on the other 
hand, the lower bounds the cost to the market of 191 2 
ditto, and the upper the value to the market of 191 2 
ditto. The pairs at L and O are the corresponding curves 
for the year 1913 ; but note that though the person for 
the curves at L is the same advancer we had for the 
curves at E^ that is, any advancer of 191 2 who at his 
margin is considering advancing the services CD to nature 
for one year, the market for the curves at O is not the 
same market we had at G but the market of 19 13. 

The services advanced — or whose advance is under 
consideration — are, as I have said, those required to 
make eight suits each having in 191 2 a market value 
corresponding to the price $12.50. They are measured 

^ I mean either the actual or the potential advancer according to 
whether he actually decides to advance the services or not. As we are 
considering the situation when he has reached the margin of his advanc- 
ing, we must admit that he is just as likely barely to fail to make the 
advance as barely to make it. 



94 A THEORY OF INTEREST 

objectively by the line CD, also designated simply a, 
which is a very small part of the base-line, LI, of Diagram 
I (§ 25) — in fact the infinitesimal part at the point V 
of that base-line — magnified, as it were, to the length 
CD. The value of these services to the market of 191 2 
is represented by the parallelogram CDHG, for the up- 
and-down dimension of that parallelogram is made 12 J 
sixteenths of an inch in length to correspond with the sub- 
jective factor of the market value of those services as it 
is indicated by the market value of each suit, which cor- 
responds to the price $12.50. This parallelogram can be 
referred to more conveniently as ab, in which expression 
a stands for the dimension CD, the objective factor of 
the value in question, and b for the dimension CO, the 
subjective factor of the same value. The value of the- 
same services, the services a, to the advancer, may differ 
from ab, of course, according to the difference between 
his personal subjective factor and b. If his personal sub- 
jective factor, which we shall call b'\ happens to be half 
that of the society of 191 2, we must make b'^ half as long 
as b, as is done in the diagram. These subjective factors 
are chosen at random : any others would serve equally 
well. 

Now consider the conditions just one year later, in 
1 913. The objective measure of the services required 
at that time to have an estimated value to the market 
of that time — in other words an estimated nominal 
value — equal to ab will depend on what the estimated 
subjective factor of the society of that time happens to be. 
If that estimated subjective factor, which we shall desig- 
nate b\ happens to be ii-J, the objective measure of the 



RELATIONS OF THE INTEREST PROBLEM 95 

services, yielded by the suits in 19 13, that equal in nomi- 
nal value the services a invested in making them in 191 2, 
must be 9 units ; for 9 times 11^ equals 8 times i2|. As 
this numerical equivalent is assumed for the case illus- 
trated, the line h' (or 10) of the diagram is given a length 
of 11^ sixteenths of an inch. 

We now have a geometrical representation of the equa- 
tion of the nominal value of the two lots of services that 
constitute, according to the definition of the principal 
always implied, though not clearly formulated, in men's 
thinking, the principal of the advance to nature we are 
analyzing ; for the parallelogram a'h' , which represents 
the nominal value of the services that constitute the prin- 
cipal of 1 9 13, is exactly equal in area to the parallelogram 
ah, which represents the nominal value of the services 
that constitute the principal of 191 2. 

§ 55. The estimated value to the advancer of the prin- 
cipal of 1 9 13, that is, of the services a' , is the next thing 
to be represented. It is determined, of course, by the 
estimated subjective factor of the advancer for 19 13. 
What, then, is that subjective factor ? All we know is 
that it must be less relatively to h" than is h' relatively 
to h. The smaller we make h'" , the greater will the 
difference be between ah'^ and a'h'" , the greater the a"h'" 
which must equal that difference, and the greater the 
a"h' which measures the natural interest in the case. 
As we must assume a magnitude for h'" , let us assume one 
for it such that our diagram will represent conditions 
about the same as those of the commercial centres of the 
world to-day, that is, as those where all persons cease 
making further advances to nature at a point where the 



96 A THEORY OF INTEREST 

nominal surplus to be got by making a further advance 
to nature for one year — in other words, where the nomi- 
nal value of such an advance — has fallen to, say, 3 % 
of the nominal value of the principal. That means draw- 

ing the line b^'^ so that — — equals yo"o ? or, since the ab 

ab 

of our diagram is 100, so that a^'b' equals 3. Well, then, 
if a^'y is to be 3, a^' must be '-^, which means ^-, which 

means -jVo '■> ^-nd if a^' is yVo > ^''' must, according to the 
second equation of § 45 (ab^^ — a'b'" = a"b'"), be sfif. 
The line b'" (or IL) of our diagram is therefore given a 
length of 5 ft Y sixteenths of an inch. And so the rectangle 
a'b'" represents the estimated value to the advancer at 
his margin of the services a' of 19 13, which constitute 
the principal of the advance under consideration. 

§ 56. Our next step is to represent in the diagram the 
estimated value to the advancer of the advance itself^ 
at his margin of advances. By this I do not mean, re- 
member, its estimated net value to him, its estimated 
value to him above its estimated cost to him. Such an 
estimated net value to him above estimated cost to him 
the advance at the margin cannot normally have. I 
mean the estimated value to him of the marginal advance 
considered independently of its possible estimated cost 
to him. To represent this estimated value we extend 
the line // past / twenty-seven hundredths (iVo) of 2, 
sixteenth of an inch and draw the rectangle having that 
added line (which we designate a") as one dimension and 
b'" as the other. The estimated value of the advance to 
the advancer is then represented by the area of the rec- 



RELATIONS OF THE INTEREST PROBLEM 



97 



tangle a"h"' (or JKNM), which is lyVs square sixteenths 
of an inch. 

The estimated cost to the advancer of the advance, 
that is, its estimated cost to him quite independently 
of its estimated value to him, is represented on the dia- 
gram by the excess of the area of the parallelogram ah" 
over that of the parallelogram a'h'" . 

The entire second equation of § 45, namely ah" — a'h'" 
= a"h"' , is now represented geometrically. For the 
excess of the area of the parallelogram ah" over that of 
the parallelogram a'h"' will be found to be precisely equal 
to the area of the parallelogram a"h"' . 

§ 57. To represent on our diagram the nominal value 
of the so-called surplus services a" , which nominal value 
measures the interest in the case (the services them- 
selves being the interest itself) , we simply draw the rec- 
tangle having a" for one dimension and h' for the other, 
that is, the rectangle JKQP. The area of this rectangle 
measures the nominal value of the so-called surplus ser- 
vices a", which nominal value measures the natural 
interest normally obtainable, under the conditions as- 
sumed, by advancing to nature for one year services 
having a nominal value (represented by the area of 
CDHG, by that of IJPO, or by that of any parallel 
cross-section of the solid figure between them) of ah 
(which corresponds to $100 in our example) and having 
an objective measure in 191 2 of <2 (which corresponds to 
eight suits of clothes in our example). The area of this 
rectangle (JKQP) is exactly 3 square sixteenths of an 
inch (which corresponds to $3 in our example). 

The rate of interest in the case is represented by the 



q8 a theory of interest 

ratio of the area a"h' (or JKQP) to the area ah, to the 
area a'h' , or to any of the other areas (of parallel cross- 
sections between them) representing the nominal value 
of the principal. As the area ah happens to be just loo 
square sixteenths of an inch, the number of the square 
sixteenths of an inch in a"h' , which is 3, is the rate per 
cent of interest in the case. 

§ 58. The question may arise in the minds of some 
readers whether it would have made any difference if we 
had supposed h" to be greater instead of less than h. 
None at all. This will be clear to anybody who considers 
the significance of the algebraic solution of the problem 
in the preceding chapter, or to anybody who, distrusting 
his own ability to reason in the terms of algebra, makes 
the test in terms of geometry. It is not the relation of 

h'" h' 
h" to h, but that of —rr to — , that causes the persistence 

h h 

of interest. 

§ 59. The compounding of interest is shown graphi- 
cally in Diagram III above by the representation of the 
principal of the advance of 1913-1914 as not the services 
a only but the services a plus the services a" . 

Compound interest is often spoken of as if it were an 
unusual and artificial species of the genus interest. The 
truth is, however, that it is simple interest that is an ar- 
bitrary conception of men's minds, corresponding but 
very imperfectly to any phenomenon discoverable in 
nature, and that the conception of compound interest 
corresponds to natural conditions. 

Compound interest is the aggregate of the prices of a 
series of advances. Of that series the first is the advance, 



RELATIONS OF THE INTEREST PROBLEM 



99 



for the first compounding period, of the services which 
constitute the original principal in the case ; the second 
is the advance, for the second compounding period, of 
services which constitute the original principal (the ser- 
vices a') plus services which constitute the interest {a") 
of the first advance ; the third is the advance, for the third 
compounding period, of services which constitute the 
principal of the second advance plus services which con- 
stitute the interest of the second advance ; and so on. In 
commercial transactions the length of the compounding 
period is fixed by law or by contract, usually as six months 
or one year. Ideally, however, it should be infinitesimal ; 
for the advance of services for the least time conceivable 

7/// 7/ 

has ideally, on account of the relation of — -- to — already 

h h 

explained, some nominal value, however small, and an 
advance for an appreciable time really involves the mak- 
ing of a series of advances, each for an infinitesimal period 
and each of services constituting the principal plus the 
interest of the previous advance of the series. 

§ 6o. The question now arises : What is the effect, if 
any, on the rate of loan interest of the customary adop- 
tion, in accordance with law or contract, of so extended 
a compounding period as six months or a year ? It is to 
raise that rate, above what it would be if the compound- 
ing period were infinitesimal, enough to make the return 
to the lender just what it would be if the compounding 
period were infinitesimal. 



CHAPTER VI 

Causes of the Normal Rate of Interest 

§ 6i. Usually, when people speak or write of the 
*' causes of interest," they mean the causes of a positive 
rate, a rate above zero. What we want, however, is 
more than that : we want a comprehensive list of the 
causes that raise and the causes that lower the rate. 

§ 62. In undertaking to determine these causes our 

h'h" 

first thought is that since — — — i is the formula for the 

hh 

7/7// 

normal rate of interest, whatever increases -— y^ must 

7 /7 // 

raise the rate, and whatever decreases — -- must lower 

DO 

the rate. That is, of course, true ; but as a criterion of 
the causes of effects on the rate it is not nearly so service- 
able as that furnished by Diagram II (of § 41), in which 
the rate is represented by the length of a line, WV . The 
advantage for our present purpose of that diagram, which 
is reproduced with a slight addition below, is that it 
reveals the causes of the length of WV , which represents 
the rate of interest, as divisible into two groups, those on 
the value side, as we may call them, and those on the cost 
side. For the length of WV is fully determined by the 
height above the base-line of the point W. But that 
point, we know, must be on both the curve OR and the 

100 



CAUSES OF THE NORMAL RATE OF INTEREST loi 



curve CH. So the conditions or causes of the rate WV 
must be susceptible of division into two groups, those 
that determine the course of the curve OR where it is to 
cross the curve CH, and those that determine the course 
of the curve CH where it is to cross OR. Nothing can 
be a cause, on the value side, of a rise or a fall in the 
normal rate of interest except a change of conditions 
that respectively raises or lowers the curve OR so as to 
raise or lower the point of intersection W ; and nothing 

K 




Diagram IV 



can be a cause, on the cost side, of a rise or a fall in the 
normal rate of interest except a change of conditions 
that respectively raises or lowers the curve CH so as to 
raise or lower the point of intersection W. All this will 
become clear as we proceed to apply it. 

§ 63. What possible conditions, then, on the value 
side might raise the normal rate of interest ? Applying 
the criterion derived from the diagram, we answer: 
Any conditions that change the course of OR so as to 
raise the point of its intersection with CH. 

Among such conditions, clearly, are those changes 
that open opportunities for making advances to nature 
considered better than those previously considered mar- 



102 A THEORY OF INTEREST 

ginal. (In this connection recall §§ 37-40 above, espe- 
cially § 40.) For example suppose the time in question 
to be that of the first successful application of electricity 
to the propelling of street-cars ; suppose the series of all 
the natural capitals — if I may use such a form of 
expression — in existence and yielding as much as the 
normal rate of interest at the time to be represented by 
LI ; and suppose the invention — as we call it — of the 
electric car to reveal opportunities for the investment 
of services, up to an amount represented objectively by 
a sixteenth of an inch on LI, in advances to nature esti- 
mated to be more valuable or advantageous than those 
standing at the point V in the series. In that case ser- 
vices, in the form of the labor of artisans, represented 
objectively by a sixteenth of an inch on LI, which would 
have been devoted, if the invention had not been made, 
to making and repairing horse-cars and horse-buses, har- 
nesses, and various other sorts of natural capital now 
displaced in the series, are now diverted to producing elec- 
tric cars and all their accessories ; and the effect of this 
on the curve OR is to raise its course from that point — 
sayiVin Diagram IV above — at which the electric cars 
and accessories standing highest take their place in the 
general series, on towards R or rather towards a point 
somewhat above R. The dotted line in Diagram IV 
indicates the course of the curve after the supposed effect 
of the invention has been felt. It is apparent that al- 
though the conditions determining the course of the 
curve CH, which are the causes of the rate of interest 
on the cost side, have remained unchanged, the point 
of intersection of the two curves is no longer W, but X, 



CAUSES OF THE NORMAL RATE OF INTEREST 103 

which is higher than W. In other words the rate of 
interest has been raised. We may therefore declare, 
with an assurance impossible, as it seems to me, to any 
economist hitherto, that inventions may be causes, on 
the value side, of a rise in the rate of interest. 

Discoveries, as of new lands or of unknown resources 
in old lands, may have on the rate of interest the same 
effect as inventions, and for the same reasons. 

So also may an extension among men generally of the 
scientific knowledge already possessed by a few; so 
may an increase, on the part of laborers, of skill in the 
handling of machinery; so may an increase of pains- 
taking in the handling of machinery ; so, indeed, may 
any change whatever that raises OR so as to raise its 
intersection with CH when the course oi CH itself 
remains unchanged. 

One more class of these changes that may raise OR 
so as to raise its intersection with CH demands special 
explanation. I refer to changes that affect opportunities 
for making advantageous advances to nature of a sort 
seldom recognized as advances at all. Let me ex- 
plain. A young man is really making an advance to 
nature when he undergoes pain and expense in training 
himself or educating himself in order to increase the 
economic value of his services, per unit of their cost, 
later. Consider the case of a lad who spends money — 
perhaps borrowed money — and works painfully hard 
to give himself a medical education. Though most of 
his expenses are for board and lodging, which he is un- 
questionably '' consuming " if a person ever consumes 
anything, those very '' expenses for consumption," as 



104 ^ THEORY OF INTEREST 

well as his labor of study beyond the point to which he 
would study for his immediate pleasure, have in them 
an element of investment or of advancement to nature. 
The advice so often given to young men, '' You cannot 
invest your time and money better than in getting a 
good education/' implies — what is literally true from a 
strictly economic point of view — that educating one's 
self is making an investment or an advance. At every 
point in the circle, or rather the spiral, of economic life 
consumption and investment meet, just as consumption 
and production meet. The food and recreation that 
give me immediate pleasure to the extent of 50 units, 
say, may also put me into condition to produce imme- 
diately, above the services I could produce without 
them immediately with the same pain, services having 
a nominal value of 20. There you have the point of 
contact between consumption and production. But 
the same food and recreation may put me into condi- 
tion to produce hy next year, above the services I could 
produce without them immediately with the same pain, 
services having a nominal value of 21 units. There 
you have the point of contact between consumption 
and investment or advancing (to nature), for the twenty- 
first unit in this latter case is the nominal value of the 
advance for one year of the services, having a nominal 
value of 20 units, which I might have consumed at the 
earlier time but decided to forego for a year. 

Here, then, to come back to our main line of thoug^ht, 
in connection with consumption itself are opportunities 
for making advances to nature that may yield a nominal 
surplus : in the case supposed just above, there was an 



CAUSES OF THE NORMAL RATE OF INTEREST 105 

opportunity to secure, by such an advance to nature 
in connection with consumption, natural interest at the 
rate of 5 per cent; for i is 5 per cent of 20. And any 
changes that affect these opportunities or men's knowl- 
edge of them must clearly affect the rate of natural 
interest from the value side precisely as do changes in 
respect to the other sorts of opportunities that we 
associate with the words " invention " and " discovery.", 
The introduction of the electric tram-car increased the 
value of advances to nature embodied in certain impres- 
sions, on the minds of young engineers, which we call 
knowledge of certain formulae and principles connected 
with the application of electricity to the propulsion of 
cars. Therefore the investment of board-bills and pain- 
ful study in this chapter of science was encouraged by 
the introduction of electric cars just as investment in 
the cars themselves was ; and the services of boarding- 
house-keepers and printers, that had formerly been 
otherwise applied, were diverted to the making of ad- 
vances to nature embodied in the additional education 
of certain young men. The finding of such new oppor- 
tunities for making advances to nature, in connection 
with the young men's consumption, considered more 
advantageous or valuable than those previously con- 
sidered marginal, has the effect of raising our curve OR 
from some such point as N on, and therefore of raising 
the normal rate of natural interest. 

§ 64. I have now mentioned several groups of causes, 
on the value side, of a rise of the normal rate of natural 
interest. How many such causes are there? That 
depends wholly on how you conceive and define them. 



lo6 A THEORY OF INTEREST 

If you conceive and define them as one comprehensive 
group, they take on the appearance of a single cause : 
conceive and define the conditions on the value side of a 
rise of the normal rate of interest as '' all that increase the 
value of the marginal advance to nature," and you have 
reduced them to a single group which might be described 
as a single cause. If, however, you mention separately 
inventions, discoveries, and so forth, as I have done, 
and then proceed to break each one of these categories 
up into smaller categories and even into particular 
events, you are ready to declare the causes on the value 
side of a rise of the normal rate of interest to be many. 
Finally, if you inquire into the causes of the causes, 
the causes of the causes of the causes, and so on indefi- 
nitely, you are ready to say that the number of possible 
causes of a rise of the normal rate of interest is infinite. 
And such an assertion cannot vahdly be denied. The 
truth is that the cause of any event, the conditions 
preceding it without which it would not have occurred, 
may be conceived by our minds under the form of in- 
finite multiphcity, under that of unity, or under that of 
some intermediate number of categories or groups ; and 
the only ground for preferring one of these conceptions to 
any other is that of its serviceabiHty in that classification 
of events in our minds which makes them, as we say, 
com-prehensi-ble to us, that is, capable of being grasped 
up together. It is only because it helps my thinking to 
do so, only because it helps me to grasp up together in 
my mind the relations (of groups of events) that I call 
the normal rate of interest and the conditions (of groups 
of events) that must precede those relations, that I first 



CAUSES OF THE NORMAL RATE OF INTEREST 107 

divide all these conditions into two groups, those on the 
value side and those on the cost side, then divide the 
former group again into those that raise the rate and those 
that lower it, and finally divide the former subgroup 
into sub-subgroups defined by the use of such words 
as invention and discovery. This classification is im- 
mensely important to my thinking; but, after all, it 
is only a classification, and not an exhaustive and rigidly 
logical one at that. The number of its separate groups, 
as well as the principle of their demarcation, is not 
determined by the facts only but partly also by the re- 
quirements of our powers of comprehending them. 

§ 65. The causes, on the value side, of a fall of the 
normal rate of interest are simply the changes of condi- 
tions contrary to those set forth above as causing a rise. 
By a change contrary to an invention which raises the 
normal rate of interest, for example, I mean such a loss, 
on the part of the race, of scientific knowledge pre- 
viously possessed as eliminates some opportunities 
to make advances to nature whose elimination must 
result in a lowering of the point of intersection of the 
two curves. This sort of change we seldom think 
of because in our age scarcely any useful invention 
is forgotten, scarcely any useful scientific knowledge 
lost ; but it is clear that if knowledge of the electric car 
were to be permanently lost, the value curve of our 
Diagram IV would fall from the course N X to the course 
NR, say, so that the point of intersection of the two curves 
would fall back from X to W. 

§ 66. The causes on the cost side that raise the normal 
rate of interest, that is, the conditions that raise the 



io8 A THEORY OF INTEREST 

height of the point of intersection of OR and C H through 

their effect on C H only, must all be included in the one 

group of the conditions that increase b'b'^ relatively 

to bb''\ This follows from the fact (see § 48) that the 

b'b'^ 
normal rate must always be the excess of -— — over i. 

bb 

But it is best to divide this comprehensive group into 
two. It will be recalled that b' and b'^^ stand, not for 
the actual subjective factors, at the later time in ques- 
tion, of the changing society and of the advancer respec- 
tively, but for those subjective factors as estimated by 
the advancer. We may therefore divide the conditions 
that increase b^b^^ relatively to bb'^' into two groups, 
those that make the advancer's subjective factor decline 
actually with the passing of tim.e, relatively to the 
changing society's, and those that make it seem to him 
to do so more than it does so actually. 

§ 67. To the first of these two groups belong, notably, 
all changes that decrease the duration of human life and 
all that diminish the degree to which men generally 
identify their heirs with themselves. The shorter a 
person's life is to be, the greater the actual decline, with 
the passing of time, of his subjective factor relatively 
to the changing society's. And the less a person iden- 
tifies his heirs with himself, the less he cares about their 
pleasure and pain, the greater the actual decline, with 
the passing of time, of his subjective factor relatively 
to the changing society's. 

§ 68. To the second of the two groups — that of 
changes which increase the advancer's estimate of the 
relative decline of his subjective factor with the passing 



CAUSES OF THE NORMAL RATE OF INTEREST 109 

of time without increasing the relative decline itself 
in reality — belong such changes as those that decrease 
men's powers of realizing, of feeling as real, their own 
future pleasures and pains and the pleasures and pains 
of their heirs. 

§ 69. I need hardly say that the causes on the cost 
side of a fall of the normal rate of interest are the changes 
contrary to those on the cost side just set forth as causing 
a rise. 

§ 70. It will be noticed that, on the cost side, it is the 
causes of a fall rather than those of a rise of the normal 
rate of interest that we are familiar with in the present 
age. At present human life is growing longer rather than 
shorter, men are probably growing more rather than less 
solicitous about the welfare of their heirs, and their error 
in overestimating the decline of their personal subjective 
factors of value, relatively to that of the changing so- 
ciety's subjective factor, is probably declining. So far 
as the causes on the cost side are concerned, therefore, 
we should expect the normal rate of interest to be falHng 
at the present time. 

On the value side, on the other hand, it is the causes of 
a rise of the normal rate of interest rather than those of 
a fall that seem to be at work nowadays. Inventions 
and discoveries that tend to raise the value hne, as from 
NW to NX, are being made rather than being forgotten ; 
an increase of technical skill, such as tends to raise the value 
line likewise, seems to be continuous ; and opportunities 
to invest in education that have the same tendency open 
up all the time. So far, therefore, as the causes on the 
value side of a rise or a fall of the normal rate of interest 



no A THEORY OF INTEREST 

are concerned, we should expect that rate to be rising 
at the present time. 

§71. Let us consider whether recent history confirms 
this theory of the causes of a rise or a fall in the rate of 
interest. The past century has been marked by an ex- 
traordinary number of inventions and discoveries, and 
by a rapid extension among men generally of the scien- 
tific knowledge first acquired by the few. So far as these 
conditions only were concerned, therefore, the tendency 
throughout the century should have been, according to 
the foregoing theory, for the rate of interest to be high. 
But on the other hand the century has not been marked 
by any tendency on the part of people generally to die 
younger, to be less solicitous about their heirs, or to be 
less rational in their estimation of future conditions ; 
rather has the tendency been in the opposite direction. 
So far as this second point only is concerned, therefore, 
the tendency throughout the century should have been, 
according to the foregoing theory, for the rate of interest 
to be kept from rising much by the making of advances 
to nature sufficient in amount to produce that effect. 
And what, according to the foregoing theory, should 
have been the result and effect of both the groups of 
conditions mentioned ? Simply the vibrating of the rate 
of interest up and down near a point above the minimum 
rate determined by the conditions on the cost side, and 
the keeping of the rate down so low as on the average it 
has been only by the supplying of advances to nature — 
in the form of railroads, machinery, buildings, and what 
not — in enormous amounts. And that is precisely 
what actually happened during the century. 



CAUSES OF DIVERGENCE FROM NORMAL RATE m 

Causes of Divergence from the Normal Rate 

§ 72. Up to this point we have been studying the nor- 
mal rate of interest, the word normal being used in a 
sense defined in § 18. We have now to consider the 
causes of the divergence from the normal of the actual 
rate. These causes, taken with those of the normal rate, 
should fully account for the actual rate under any cir- 
cumstances. 

§ 73. The nature of these causes is suggested in the 
definition of the word normal in § 18. Excepting only 
the cause implied in the fifth paragraph of § 41 and re- 
ferred to in § 66 and § 68, namely the error of estimation 
on the part of the advancer, which I have included in 
the group of those that determine the rate I call normal, 
all causes whatever that prevent men's acting, in respect to 
the making of advances, according to their best economic 
interests would be classed by me as those that make the 
actual rate of interest diverge from the normal rate. 
Nearly all these preventing conditions may be called 
the imperfections of the market in advances. Specific 
examples lie all about us. In Alaska, let us say, there 
are many opportunities to make advances ^ to nature 
whose (nominal) value will be 8 % of the principal, in 
other words many opportunities to make advances to 
nature that will "earn 8 %." At the same time there 
are many persons in the United States — to say nothing 
of those in Alaska and elsewhere — who are aware that 

^ It is to be remembered that an advance, as I use the word, is not 
the goods, or services advanced, which are things of two dimensions, 
but a thing of three dimensions, as explained in § 30. 



112 A THEORY OF INTEREST 

such opportunities exist and who would gladly make 
some of the 8 % advances, in addition to all the advances 
they make at present, but who are prevented from mak- 
ing them by fear of being swindled or by inabiHty to get 
together in cooperation enough other persons of Kke 
desires to make the investment to such advantage as to 
yield the 8 % mentioned. Thus the fear of dishonesty 
and the inability of large numbers of scattered persons 
to put their small advances together so as to invest 
them to the best advantage, — these are two notable 
sorts of preventing conditions that cause the actual rate 
of interest to diverge from the normal rate. Such con- 
ditions are most prevalent, evidently, in new and com- 
mercially ill-organized communities, and least prevalent 
in commercially well-organized communities, that is, 
those in which such institutions as '' Dun's " and 
" Bradstreet's " and all kinds of banks are highly 
developed. 

The effect on the actual rate of interest of such imper- 
fections of the market in advances as I have just men- 
tioned is, of course, to raise it. In the light of the previ- 
ous chapters the reason is clear. Any conditions must 
raise the actual rate of interest, the nominal value of 
advances per unit of the principal, which tend to reduce 
the supply of advances to nature. And such im^perfec- 
tions in the market for advances obviously tend to re- 
duce the supply of advances to nature just as any im- 
perfections in the market for any sort of goods tend to 
reduce the supply of that sort of goods ; for an obstruc- 
tion to the purchase of any good is an obstruction to its 
virtual production (through demand) by the person who 



CAUSES OF DIVERGENCE FROM NORMAL RATE 113 

would purchase it if the obstruction did not exist ; and 
an obstruction to the borrowing of wealth, which is equiv- 
alent to the purchase of an advance to nature, is an 
obstruction to the virtual making of that advance 
(through demand) by the person who would borrow the 
wealth if the obstruction did not exist. 

It must not be inferred, however, that the effect of all 
imperfections of the market in advances must be to raise 
the actual rate of interest. Imperfections of another sort, 
namely those that tend to prevent the withdrawal of 
advances that have once been made, must lower the rate 
of interest. Just as there are hindrances in the way of 
making investments which are perfectly satisfactory 
to the investor so far as all the considerations briefly 
explained above are concerned, so there are hindrances 
in the way of un-making investments which have become 
unsatisfactory to the investor so far as these same con- 
siderations are concerned. And these latter hindrances 
tend to reduce the actual rate of interest. An example of 
these hindrances is the practical difhculty of spending to- 
day ten dollars of the thousand you lent last week to the 
United States Steel Company by buying one of its bonds. 
Of course you could shift the bearing of the advance of 
the $10 to other shoulders by borrowing $10, on the 
security of your bond, at a bank ; but in the way of your 
doing so is a considerable hindrance, the bother that 
the transaction would entail on yourself and the bank. 
Very likely you will go on advancing the $10 through 
days or weeks when, so far as the principles discussed 
in this book above are concerned, you prefer not 
to ; and in that case you thereby lower the actual rate 



114 A THEORY OF INTEREST 

of interest as the result of conditions not covered by the 
word normal as I use it. 

§ 74. Having now accounted for what I call the nor- 
mal rate of interest, and for the divergencies from that 
normal rate that result in the actual rate, I must make 
another important distinction. Distinct from the actual 
rate of interest under any conditions there is a somewhat 
higher rate which appears in the case of any advance in- 
volving an appreciable risk of losing the principal. This 
might be called the actual rate as modified by a factor of 
risk. The reason why I do not call it the actual rate 
simply is that only a part of what appears to be interest 
in the case is interest proper, the rest being clearly a 
return to the advancer necessary to induce him to take 
the risk of losing the principal involved in the case. 
Suppose two loans to be made in the same loan market — 
and that the most perfectly organized market in the world 
— and suppose them to be made at the same time. Even 
under those conditions one may be at what is called, in 
business transactions, ''6 % interest," the other at what 
is called ''3 % interest." Under those conditions the 
difference between 6 and 3 is not a difference between 
rates of what is really interest : it is a difference between 
rates of, on the one hand what is really interest plus the 
price of the bearing of a certain risk of losing the principal, 
and on the other hand what is really interest plus virtu- 
ally nothing in the guise of such a price of risk-bearing. 
Thus in the case of both loans the actual rate, prop- 
erly speaking, is barely less than 3 %, the extra 3 % of 
the 6 % in one of the cases arising from causes distinct 
from those giving rise to interest proper. 



CAUSES OF DIVERGENCE FROM NORMAL RATE 115 

§ 75. Finally, distinct from the actual rate as modi- 
fied by the factor of risk is the same rate as further mod- 
ified by expected changes, between the beginning and 
the end of the time covered by the advance, in the nomi- 
nal value of the money or goods named as the principal. 
I say the nominal value ' ' of the money or goods named as 
the principal " instead of saying simply the nominal value 
''of the principal" because, by definition, the principal 
is a thing whose nominal value does not change with the 
passing of time. If you think of lending me $100 for a 
year, say, at a time when you think a dollar will depre- 
ciate during the year 2 %, you have no economic motive 
for making the loan unless you get back not only interest 
but also $2 to cover what has sometimes been called 
depreciation of the principal but what cannot be called 
that by any one who has defined principal correctly. 
The principal in the case, really, is $100 at the beginning 
of the year and $102 at the end of it, and the interest 
(as modified by the factor of risk) is the difference be- 
tween all that you exact at the end of the year and $102. 
If, then, what you exact at the end of the year is $106, 
the actual rate of interest as modified by the factor of 
risk in the case is really 1^2- To any one, however, 
who did not fully understand what the principal is, that 
rate as thus modified would appear to be yfo, or 6 %. 
The rate thus made up on the basis of a misconceived 
principal we may call the apparent rate} 

1 In this paragraph I have covered what is discussed by many writers 
under the head of interest and money. See, for example, Pantaleoni's 
Pure Economics, Part III, Chap. Ill, 7; Marshall's Principles, pp. 
676-677; I. Fisher's The Rate of Interest, pp. 257-288; and G. Cassel's 
Nature and Necessity of Interest, Chap. V, especially pp. 163-166. 



Ii6 A THEORY OF INTEREST 

§ 76. From the ''apparent rate" of interest in any 
specific case we could determine, if we allowed for the 
error in conceiving the principal, the ''actual rate as 
modified by the factor of risk" in the case. From this 
latter rate we could then determine, if only we could 
subtract the price necessary to induce the advancer to 
assume the risk in question, the "actual rate" (apart 
from risk). And, having the actual rate apart from 
risk, we could determine the "normal rate" of interest 
if we could subtract from the actual rate or add to it 
just enough to cover the effects of the imperfections 
of the market in advances and of other hindrances — 
aside from those I have referred to in § 66 and § 68 in 
connection with "estimation" — to men's acting, so far 
as advances are concerned, in accordance with their 
best economic interests. But these are important ifs : 
in reality we cannot know precisely how much to sub- 
tract from apparent interest to get actual interest or 
how much to subtract from or to add to actual interest 
to get normal interest. Nor is it important that we 
should do these things : what is important is merely 
that we should understand, first, the nature of that part 
of apparent interest which is not really interest at all, 
secondly, the nature of the hindrances which cause 
actual interest to differ from normal interest, and, thirdly 
and above all, the nature and causes of normal interest. 
These important ends I hope I have forwarded in this 
book. 



CHAPTER VII 

Other Theories of Interest 

§ 77. So far as I know, no explanation of interest 
advanced hitherto has contained a definition of the prin- 
cipal at once explicit and defensible. And surely, since 
interest is nothing but a surplus above principal, failure to 
define the principal correctly is a defect in a theory of 
interest that is truly fundamental. To me, therefore, 
every theory of interest advanced hitherto with which 
I am acquainted is not merely incorrect in details but 
inadequate essentially. 

I propose now to examine critically some of the out- 
standing specific features of the most noteworthy theories 
of interest that have recently been in vogue. 

"Differences in Want and Provision for Want" 

§ 78. I begin with what has been suggested as a cause 
of interest by several authors and has been presented in 
its classical form by Professor Bohm-Bawerk (as "the 
first great cause of difference in value between present 
and future goods") under the name of ''the different 
circumstances of want and provision (Bedarf und Deck- 
ung) in present and future." ^ 

^ See Chapter II of Book V of The Positive Theory of Capital by Eugen 
von Bohm-Bawerk, translated by William Smart, London, 1891, Mac- 
millan & Co. 

117 



Il8 A THEORY OF INTEREST 

These words last quoted describe in general terms 
what I also hold to be the cause of interest : it is pre- 
cisely the "different circumstances of want and provision 
in present and future," on the part of any advancer, that 
make him, according to my theory, unwilling to make 
advances, that is, unwilling to exchange present goods 
for future goods, beyond the point where he gets a cer- 
tain nominal surplus by doing so. Yet I know of no 
author whose treatment of this point reveals the true 
cause of interest. Bohm-Bawerk's chapter on it — to 
restrict the criticism to that — besides defining the prin- 
cipal incorrectly,^ fails to prove the essential point that 
in the preponderating number of cases the relation be- 
tween want and provision in the present as compared 
with that in the future is such as to make present goods 
more valuable than future goods. An examination of 
the chapter, as reprinted below, will show the reader 
that the essential point I speak of depends on the truth 
of the assertion, found in the latter part of the third 
paragraph, that the cases are rare in which ''it is difhcult 
or impracticable to keep the present goods till a time of 
worse provision comes." And that assertion is by no 
means true : in fact it is very costly, in most cases, to 
keep present goods till a time of worse provision in the 
future. Even so durable a thing as a plow has to be 
housed if it is not to deteriorate rapidly ; and roofs cost 
labor and wear out in a few years. 

1 See the third sentence of Bohm-Bawerk's chapter, quoted below. 

The same erroneous definition of the principal is implied by many 
other writers, for example by Professor F. A. Fetter, on page 135 (Chap. 
16, § II, i) and page 141 (Chap. 17, § i, i) of his admirable Principles 
of Economics (The Century Co., N. Y., 1907). 



OTHER THEORIES OF INTEREST 



119 



Following is the chapter itself, as translated by Pro- 
fessor Smart. 

"Differences in Want and Provision for Want^^ 

"The first great cause of difference in value between 
present and future goods consists in the different cir- 
cumstances of want and provision {Bedarf und Deckung) 
in present and future. Present goods, as we know, re- 
ceive their value from the circumstances of want and 
provision in the present : future goods from the same 
circumstances in those future periods of time when they 
will come into our disposal. If a person is badly in want 
of certain goods, or of goods in general, while he has 
reason to hope that, at a future period, he will be better 
off, he will always value a given quantity of immediately 
available goods at a higher figure than the same quantity 
of future goods. In economic life this occurs very fre- 
quently, and may be considered as typical in the two fol- 
lowing cases. First, in all cases of immediate distress and 
necessity. A peasant who has had a bad harvest, or sus- 
tained loss by fire, an artisan who has had heavy ex- 
penses through illness or death in his family, a labourer 
who is starving ; all these agree in valuing the present 
shilling, which lifts them out of direst need, ever so much 
more than the future shilling, — the proof being the usuri- 
ous conditions to which such people often submit in order 
to raise money at the moment. Second, in the case of 
persons who have reason to look forward to economical 
circumstances of increasing comfort. Thus all kinds of 
beginners who have no means, such as young artists, law- 
yers; officials, budding doctors, men going into business, 



I20 A THEORY OF INTEREST 

are only too ready, in return for a sum of present 
goods which assists them to start in the vocation they 
have chosen, and acts as foundation of their economical 
existence, to promise a considerably larger sum on the 
condition that they do not require to pay it until they are 
in receipt of a decent income. 

''Of course the contrary also occurs not unfrequently 
in economical life. There are persons who are com- 
paratively well off at the moment, and who are likely 
to be worse off in the future. To this category belongs, 
among others, that very considerable number of people 
whose income is obtained, mostly or altogether, by 
personal exertions, and will, presumably, fall away at a 
later period of life when they become unfit for work. 
A merchant's clerk, for instance, who is in his fiftieth 
year, and has an income of £ioo, cannot expect to have 
anything better ten years later than, perhaps, a small 
retiring allowance of £30, or an annuity which he may 
secure by purchase at an assurance office. It is evident 
that to such people the marginal utility that depends on 
a shilling spent now is smaller than that depending on a 
shilling available in the more badly secured future. It 
would seem that, in such cases, a present shilling should be 
less valued than a future one. And so it would be if pres- 
ent goods were necessarily spent in the present, but that 
is not the case. Most goods, and among them, particu- 
larly, money, which represents all kinds of goods indiffer- 
ently, are durable, and can, therefore, be reserved for the 
service of the future. The case, then, between present 
and future goods stands thus. The only possible uses 
of future goods are, naturally, future, while present goods 



OTHER THEORIES OF INTEREST 121 

have the same possibility of future use, and have besides 
— according to choice — either the present uses, or those 
future ones which may turn up in the time that inter- 
venes between the present moment and the future point 
of time with which the comparison is being made. 

''Here then are two possibihties. Either it is the case 
that all those uses of the present and near future, which 
are generally taken into consideration as regards the good 
in question, are less important than the future uses ; and 
in this case the present good will be reserved for these 
future uses, will derive its value from them, and will be 
just equal in value to a future good similarly available. 
Or it is the case that one of the earlier uses is more im- 
portant ; and then the present good gets its value from 
this use, and has, therefore, the advantage over the 
future good, which can only obtain its value from a less 
important future employment. But, usually, one never 
knows that some unforeseen occurrence in the near 
future may not give rise to some more urgent want. At 
any rate such a thing is possible, and it gives a chance 
of profitable employment to a good already on hand, 
such as, naturally, a good that will only come into our 
possession in the future has not got ; — a chance which, 
as we have seen, is calculated in the amount of the value, 
and assessed, according to practical although incorrect 
methods, as an increment graduated according to its 
probability. To put it in figures. With £100 which will 
come into my hands at the end of five years, I can only 
aim at a marginal utility determined by the situation of 
things in the year 1896 ; we shall put this utility down at 
1000 ideal units. With £100 at my disposal now, I can, 



122 A THEORY OF INTEREST 

at the least, realise the same marginal utility of looo 
units, but if an urgent want, arising in the meantime, 
gives me an opportunity of obtaining a marginal utiHty 
of 1 200, I may, possibly, reahse it. Say, now, that the 
probability of such an opportunity occurring equals 
one- tenth, I shall estimate the value of the present £100 
at 1000 units certain, and, beyond that, at one-tenth of 
the possible surplus of 200 ; that is, in all, at 1020 units. 
Present goods are, therefore, in the worst case, equal in 
value to future goods, and, as a rule, they have the ad- 
vantage over them in being employed as a reserve. The 
only exception occurs in those comparatively rare cases 
where it is difficult or impracticable to keep the present 
goods till the time of worse provision comes. This 
happens, for instance, in the case of goods subject to rapid 
deterioration or decay, such as ice, fruit, and the like. 
Any fruit merchant in harvest time will put a consider- 
ably higher value on a bushel of grapes to be delivered in 
April than on a bushel of grapes in his store at the time. 
Or say that a rich man is anticipating a long period of 
arrest, during which his living will be conformed to the 
hard fare of prison regime, how willingly would he give 
the price of a hundred present luxurious meals if he could 
ensure ten such meals during his captivity ! 

''We may, then, draw up the balance-sheet which 
shows the influence of the different circumstances of 
Want and its Provision in present and future as follows. 
A great many persons who are not so well provided for in 
the present as they expect to be in the future, set a con- 
siderably higher value on present goods than on future. 
A great many persons who are better provided for in 



OTHER THEORIES OF INTEREST 



123 



the present than they expect to be in the future, but who 
have the chance of preserving present goods for the 
service of the future, and, moreover, of using them as a 
reserve fund for anything that may turn up in the mean- 
time, value present goods either at the same figure as 
future, or a httle higher. It is only in a fractional mi- 
nority of cases, where communication between present 
and future is hindered or threatened by peculiar circum- 
stances, that present goods have, for their owners, a 
lower subjective use value than future. This being the 
state of things, even if there was nothing else co-operating 
with this difference of want and provision in present and 
future, the resultant of the subjective valuations, which 
determines the objective exchange value, would ob- 
viously be such that present goods must maintain a pro- 
portionate advantage, a proportionate agio over future. 
But, besides this, there are other co-operating circum- 
stances which work, even more distinctly, in the same 
direction." 

Besides the criticisms on this chapter that I have made 
already one more is called for : the chapter quite fails 
to reveal the true bearing of want and provision at two 
separated times on the persistence of interest. That 
bearing is shown, it seems to me, only by an analysis 
essentially like that of Chapter IV of this book. 

''Underestimation of Future Pleasures and 

Pains" 

§ 79. A second cause of interest, advanced by many 
writers and included in my theory, is what Bohm-Bawerk 



124 ^ THEORY OF INTEREST 

calls ^ the tendency to '^ attach a less importance to 
future pleasures and pains simply because they are 
future." This is given a place in my theory,^ it will be 
recalled, as a notable condition of that error of estima- 
tion — in respect to the cost and the value, to the ad- 
vancer, of a proposed advance — which would prevent 
some advances whose value to him would in reality be 
greater than their cost to him. 

To regard this cause as acting cumulatively with others 
that limit the supply of advances, as do Bohm-Bawerk 
and some other writers, seems to me entirely correct; 
but to give it as such a cause without explicitly mention- 
ing any other such cause (see § 66 above), as do some 
writers, not including Bohm-Bawerk, is to offer a theory 
that is altogether inadequate. For it is clear from the 
analysis in Chapter IV above that interest would persist, 
provided only that men did not live forever and did not 
regard the pleasures and pains of their remote descendants 
as virtually their own, whether or^ not anybody ever under- 
estimated his own future pleasures and pains, in other 
words whether or not anybody ever underestimated his 
own future subjective factor of pleasure and pain rela- 
tively to that of the changing society. 

"Technical Superiority or Present Goods" 

§ 80. Consider now the third of the three conditions 
advanced by Bohm-Bawerk as the causes of interest, 
what he calls the "technical advantages residing in pres- 
ent goods," as compared with future goods, due to the 

1 Positive Theory of Capital, p. 253. 

2 See the fifth paragraph of § 41 and §§ 66 and 68. 



OTHER THEORIES OF INTEREST 125 

alleged superiority, explained in Chapter V of Book V 
of The Positive Theory of Capital, of long over short 
processes of production. 

The grounds of this third cause, which Bohm-Bawerk 
calls the ''chief pillar" ^ of his whole theory, are fully 
set forth by him in a passage, beginning at page 260 of 
his translated work, which the reader is requested to 
examine at this point. The passage consists of the first 
three paragraphs of the excerpts reprinted from Bohm- 
Bawerk in § 82 below. The heart of it is this sentence 
at the end of the first paragraph: ''As a rule, present 
goods are, on technical grounds, preferable instruments 
for the satisfaction of human wants, and assure us, 
therefore, of a higher marginal utility than future goods." 

§ 81. Now it is true, for the reasons given in §§ 43-47 
above, that present goods are, to any person or group of 
persons, preferable instruments, for the satisfaction of 
their wants, to future goods of the same nominal value. 
And therefore, of course, present goods command, in 
any exchange of present for future goods, a premium over 
future goods of the same nominal value. Therefore, too, 
the supply of advances to nature — that is, that of 
advances of services embodied in machinery, railroads, 
houses, and other future-service goods — is checked at the 
point where the only possible suppliers of such advances, 
namely particular persons or groups of persons, esti- 
mate the value to them of a further advance as no greater 
than its cost to them. And when advances to nature 
cease at that point, the services of the future-service 
goods are bound to show, when they accrue with the 

^ Work cited, p. 264. 



126 A THEORY OF INTEREST 

passing of time, a nominal surplus over present services 
equal to them in value to the advancers. And it is this 
nominal surplus, this preferability, from the point of 
view of the changing society contemporary with each 
moment of the passing time, of the future services that 
will be yielded by present future-service goods to those 
present goods themselves, that Bohm-Bawerk miscon- 
ceived as a ''technical superiority" of present goods 
that are capable of yielding future services (and there- 
fore of any present goods of the same market value) to 
future goods or services of — -as I should express it — 
the same nominal value. The principle that "round- 
about methods" of production ''lead to greater results 
than direct methods," then, which Bohm-Bawerk con- 
siders "one of the most important and fundamental prop- 
ositions in the whole theory of production," becomes, when 
rightly conceived, merely the principle that opportunities 
exist for so embodying present labor in advances to nature 
that the future services resulting shall exceed in nominal 
value the present services which that labor might have 
tendered instead. And that these opportunities remain 
open is due — - to repeat again the point I have repeated 
so often — to the fact that the supply of advances to 
nature, which are inevitably involved in making the 
labor yield its services in the future instead of in the 
present, is limited, for the reasons explained in the pre- 
ceding chapters, at the point where future services, when 
they accrue, show a nominal surplus over present services 
that are exactly equivalent to them from the point of 
view of the advancers, or in other words at the point 
where, in the estimation of advancers, present services 



OTHER THEORIES OF INTEREST 127 

have more value to them than future services of the same 
nominal value will have. 

This, together with what I say in the third paragraph 
of § 84 below in regard to the conception of "productiv- 
ity/' seems to me to express the true conception of the 
facts which Bohm-Bawerk misconceived as the ^^techni- 
cal advantage residing in present goods," as compared 
with future goods, due to the superiority of long over 
short processes of production. 

§ 82. Some of Bohm-Bawerk's errors on this point 
should, perhaps, be pointed out specifically. 

In the first place it is not true — though Bohm-Bawerk 
implies it throughout ^ — that processes long in time are 

^ The Positive Theory of Capital, p. 19: "The lesson to be drawn 
from all these examples alike is obvious. It is — ■ that a greater result 
is obtained by producing goods in roundabout ways than by producing 
them directly. Where a good can be produced either way, we have the 
fact that, by the indirect way, a greater product can be got with equal 
labour, or the same product with less labour." 

Same work, p. 260: "It is an elementary fact of experience that 
methods of production which take time are more productive. That is 
to say, given the same quantity of productive instruments, the lengthier 
the productive method employed the greater the quantity of products 
that can be obtained." 

Same work, p. 84 : " On the whole it m.ay be said that not only 
are the first steps more productive, but that every lengthening of the 
roundabout process is accompanied by a further increase in the tech- 
nical result ; as the process, however, is lengthened the amount of prod- 
uct, as a rule, increases in a smaller proportion. This proposition 
also is based on experience, and only on experience. What it says must 
be simply taken as a fact of the technique of production." 

Same work, p. 91 : "By means of these primary productive powers 
man may make the consumption goods he desires, either immediately, or 
through the medium of intermediate products called Capital. The latter 
method demands a sacrifice of time, but it has an advantage in the quan- 



128 A THEORY OF INTEREST 

necessarily more productive — in any sense of the word — 
per unit of labor than processes shorter in time. To suppose 
this to be true is an error analogous to supposing that the 
more a thing costs, the greater must be its value. Into this 
latter error Bohm-Bawerk would be, of all men, the last to 
fall ; and that he fell into the former one is surprising. 

It is true, of course, that many of the processes that are 
"most productive," in the sense, say, of yielding services 
of the most nominal value, require also a long time. 
But that is not because to lengthen a process in time is 
necessarily to make it more productive in that sense : 
it is because any lengthening of a process that does 
happen to increase the nominal value of the services 
resulting is limited, for the reasons already explained 
in this book, at the point where the advancing involved 
in the lengthening of the process barely fails to yield the 
advancers a surplus-to-them, and where, therefore, it 
must yield them a nominal surplus persistently. 

It will be seen that these several amendments to the 
"main pillar" of Bohm-Bawerk's theory of interest are 
all involved in the one change of substituting for his 
vague "future goods" the definite and correct conception 
of future goods ^ of the same nominal value as the present 
goods with which they are to he compared. The moment 

tity of product, and this advantage, although perhaps in decreasing 
ratio, is associated with every prolongation of the roundabout way 
of production." 

^ This is the correct conception of the principal so far as goods are 
concerned. Of course the most helpful conception of the principal, 
as I have previously pointed out, is the conception of it in terms not of 
goods at all but of services. The best substitute for Bohm-Bawerk's 
"present goods and future goods" is present services and future services 
of the same nominal value. 



OTHER THEORIES OF INTEREST 129 

that substitution is made, we are in a fair way to discover 
that the supposed '^technical superiority" of present 
goods over future goods is not a technical superiority at 
ah but a superiority in exchange value from the point 
of view of particular persons or groups of persons (as 
distinguished from the changing group which composes 
the society of the passing time). 

It is well worth while to inquire next how so able a 
thinker as Bohm-Bawerk could have come to so errone- 
ous a conclusion on this point. He came to it, strangely 
enough, by way of the fallacy that lesser minds have 
fallen into so often, the fallacy of reasoning in a circle. 
As we have seen, the true reason why ''long processes" 
are ''more productive" than "short processes" is that 
"present goods" command a premium over "future 
goods." If, therefore, we proceed to say that the pre- 
mium which "present goods" command over "future 
goods" is due to the "greater productivity" of present 
goods, we have simply completed the circuit and come 
back to the point we started from. 

FaiHng to conceive clearly just why "longer processes" 
are "more productive" than "shorter processes," Bohm- 
Bawerk not unnaturally thought he saw in the fact that 
the longer processes which men adopt are often in some 
sense "more productive" than shorter processes a reason 
why "present goods" command a premium over "future 
goods" that in some ill-defined sense are equal to the 
"present goods" except for their difference of time. 
His error may be traced in the following passages of 
The Positive Theory of Capital. The italic capitals, 
which are mine, indicate words that betray the error 



130 A THEORY OF INTEREST 

most clearly. The ordinary capitals, which are also mine, 
indicate words that imply an inadequate or incorrect 
definition or conception of the principal.^ The small 
italics are those of Smart's text. My comments on the 
passage, which immediately follow it, may well be read 
before as well as after the passage itself. > 

"There is still a third reason why present goods are, 
as a rule, worth more than future. The fact on which 
it is based has long been known in a general way, but its 
essential nature has been thoroughly misunderstood. 
Hidden in a perfect wilderness of mistakes, economists 
ever since Say and Lauderdale have been in the habit 
of going to it, under the name 'productivity of capital,' 
for their explanation and justification of Interest. This 
name, which has already been the cause of so many 
errors, and which, besides, does not altogether corre- 
spond with what it is intended to convey, I shall lay on 
one side, and shall confine myself to the facts of the case 
pure and simple. These facts are as follows : — that, as a 

1 In this connection may be quoted also some other passages from 
The Positive Theory of Capital which strongly suggest an erroneous 
conception of the principal. 

P. 249 : " If a person is badly in want of certain goods, or of goods in 
general, while he has reason to hope that, at a future period, he will be 
better off, he will always value a given quantity of immediately available 
goods at a higher figure than the same quantity of future goods." 

Same work, p. 91 : "The latter method demands a sacrifice of time, 
but it has an advantage in the quantity of product, and this advantage, 
although perhaps in decreasing ratio, is associated with every prolonga- 
tion of the roundabout way of production." 

Same work, p. 82: "With an equal expenditure of primary pro- 
ductive powers (that is to say, labour and valuable natural powers) 
more or better goods can be produced by a wisely chosen capitalist 
process than could be by direct unassisted production." 



OTHER THEORIES OF INTEREST 131 

rule, present goods are, on technical grounds, preferable 
instruments for the satisfaction of human want, and assure 
us, therefore, a higher marginal utility than future goods. 

''It is an elementary fact of experience that methods 
of production which take time are more productive. 
That is to say, given the same QUANTITY of productive 
instruments, the lengthier the productive method em- 
ployed the greater the QUANTITY of products that can 
be obtained. In previous chapters we went very thor- 
oughly into this, showed the reasons of it, and illustrated 
and confirmed it by many examples. I venture to think 
we may now assume it as proved. If, then, we take an 
AMOUNT of productive instruments available at a 
certain point of time as given, we have to represent 
the product, which may be turned out by increasingly 
lengthy processes, under the picture of a series increas- 
ing in a certain ratio, regular or irregular. Suppose that, 
in the year 1888, we have command of a definite 
QUANTITY of productive instruments, say, thirty days 
of labour, we may in terms of the above proposition, as- 
sume something like the following. The month's labour, 
employed in methods that give a return immediately, 
and are, therefore, very unremunerative, will yield only 
100 UNITS OF PRODUCT : employed in a one year's 
process, it yields 200 UNITS, but, of course, yields them 
only for the year 1889 : employed in a two years' process 
it yields 280 UNITS — for the year 1890 — and so on 
in increasing progression: say, 350 UNITS for 1891, 
400 for 1892, 440 for 1893, 470 for 1894, and 500 for 1895. 

"Compare with this what we may get from a similar 
QUANTITY of productive instruments, namely, a 



132 



A THEORY OF INTEREST 



month's labour, under the condition that we do not get 
possession of the labour till a year later. A month's 
labour which falls due in the year 1889 evidently yields 
nothing FOR THE ECONOMIC YEAR 1888. IF 
ANY RESULT IS TO BE GOT FROM IT IN THE 
YEAR i88g it can only be by employing it in the most 
unremunerative (because immediate) production, and 
that result will be, as above, 100 units. IN i8go it is 
possible to have a return of 200 units by employing it 
in a one year's method of production ; IN i8gi to have 
280 units by employing it in a two years' process, and so 
on. In exactly the same way, with a month's labour 
falHng due two years later, in 1890, nothing can be 
had to satisfy the wants of THE ECONOMIC YEARS 
1888 AND i88g, while 100 units may be got FOR i8go 
by an unremunerative immediate process, 200 FOR 
i8gi, 280 FOR i8g2, and so on. If we group together 
in one table the result obtainable for the satisfaction of 
our wants from a similar amount of present, next year's, 
and succeeding years' productive instruments, we get 
the following scheme : — 

A Month's Labour of the Year 



Yields for the 
Economic 
Period 



1888 
1889 
1890 
1891 
1892 

1893 
1894 

1895 



1888 


1889 


1890 


1891 


100 








200 


100 






280 


200 


100 




350 


280 


200 


100 


400 


350 


280 


200 


440 


400 


350 


280 


470 


440 


400 


350 


500 


470 


440 


400 



Units of Prod- 
uct 



OTHER THEORIES OF INTEREST 133 

Putting these figures into words, the table shows that, 
whatever economic period we may fix upon, our economic 
interests for that period are more advanced by a month's 
labour of 1888 than by a month's labour of 1889, by one of 
1889 than by one of 1890, and so on. TO MEET THE 
WANTS OF 1888, for example, a month's labour ex- 
pended in the year 1889 or 1890 gives us nothing, while 
a month's labour expended in 1888 places at our com- 
mand at least 100 units of product. TO MEET THE 
WANTS OF i8qj a month of 1890 gives us 350 units, 
a month of 1889 400 units, a month of 1888 440 units. 
Whatever period of time we take as our standpoint of 
comparison, the earlier (present) AMOUNT of produc- 
tive instruments is seen to be superior, technically, to 
the equally great later (future) AMOUNT. 

''But is it superior also in the height of its marginal 
utility and value ? Certainly it is. For if, in every 
conceivable department of wants for the supply of which 
we may or shall employ it, it puts more means of satis- 
faction at our disposal, it must have a greater importance 
for our wellbeing. Of course I am aware that the greater 
amount need not always have the greater value ; — a 
bushel of corn in a year of famine may be worth more 
than two bushels after a rich harvest; a silver shilling 
before the discovery of America was worth more than 
five shilKngs are now. But for one and the same person, 
at one and the same point of time, the greater amount has 
always the greater value ; whatever may be the absolute 
value of the bushel or the shilling, this much is certain, 
that, for me, two shillings or two bushels which I have 
to-day are worth more than one shilling or one bushel 



134 A THEORY OF INTEREST 

which I have to-day. And in our comparison of the value 
of a present and a future AMOUNT of productive instru- 
ments the case is exactly similar. Possibly the 470 units 
of product which may be made from a month's labour 
in 1889 for the year 1895, are worth less than the 
350 units which may be got from the same for the 
year 1892, and the latter, notwithstanding their num- 
bers, may be the most valuable product which can be 
made out of a month of 1889 in general. In any case 
the 400 units which a man can gain by a month's labour 
of the year 1888 for the year 1892 are still more 
valuable, and therefore the superiority of the earher 
(present) amount of productive instruments — here and 
everywhere, however the illustration may be varied — 
remains confirmed. 

"The truth of the proposition, that the technical 
superiority of present to future means of production 
must also be associated with a superiority in value, may 
be made absolutely convincing by mathematical evidence 
if the tabular comparison, which we have drawn out to 
show the technical productiveness of different years of 
productive instruments, be extended to the marginal 
utility and value of the same. And since we have to 
deal here with a proposition which will form the chief 
pillar in my interest theory, I prefer to err on the side of 
making it too plain rather than risk not making it plain 
enough, and I shall spare no pains to prove it in the 
most complete way. In other respects, too, the trouble 
it costs us will not be altogether lost : as we proceed we 
shall get an occasional glimpse into certain relations 
which are seldom or never taken thought of, and yet. 



OTHER THEORIES OF INTEREST 135 

none the less, have some importance towards giving us 
a complete and thorough grasp of the whole. 

''The marginal utiHty and value of means of produc- 
tion depend, as we know, on the anticipated marginal 
utility and value of their product. But the means of 
production of which we have been speaking, the month's 
labour, may be invested in a production that yields an 
immediate return, or in a one, two, three, or ten years' 
period of production, and, according as it is so invested, 
we may obtain the very different product of 100, 200, 
280, 350 units, and so on. Which of these products is 
to be our standard? The foregoing chapters have al- 
ready given us the answer. In the case of goods which 
may be employed in different ways yielding different 
marginal utilities, it is the highest marginal utility that 
is the standard. Therefore, in our present case, it is that 
product which produces the greatest amount of value. 
But this need not coincide with the largest product, the 
product which contains the greatest number of units; 
on the contrary, it seldom or never coincides with that. 
We should obtain the greatest number of units by an 
infinitely long production process, or a process lasting 
a hundred or two hundred years. But goods which 
first come into possession in the lifetime of our grand- 
children or great-grandchildren, have, in our valuation 
of to-day, little or no value. 

''In determining which, of various possible products, 
has the highest value for us, we are guided by the two 
considerations of which we have just spoken. First, we 
are guided by the anticipated position of our provision 
at the various periods of time. If, for instance, a man 



136 A THEORY OF INTEREST 

is ill provided for in the present, or not provided for at 
all, the UNIT OF PRODUCT ^ in the present may, 
on that very account, have so high a marginal utility 
and value, that the sum of value of 100 present units of 
product is greater to him than that of 500 units which he 
might have at his command in 1895. To another man, 
again, whose present is as well provided for, or nearly 
as well provided for, as his future, the advantage in 
numbers may give an advantage in value to the 500 
units. The second consideration by which we are guided 
is, that our present valuation of a future good or product 
does not depend on its true marginal utility, but on our 
subjective estimation of the marginal utiHty. But, in 
forming this subjective estimate, there takes place, as 
we have already seen, a kind of perspective diminution ; 
a diminution which is in direct ratio with the futurity 
of the time to which the good in question belongs. The 
amount of which we are in search, therefore, the greatest 
sum of value, will evidently belong to that one, among 
the various possible products, the number of whose 
items, multiplied by the value of the unit of product 
(as that value shows itself with regard to the relation of 
want and provision for want in the particular economic 
period, and with regard to the diminution which future 
goods undergo from perspective) gives the greatest 
amount of value. 

*'We shall put our illustration in figures chosen at 
random. I wish to emphasize that the figures can be 

^ By the word "unit" here Bohm-Bawerk must mean unit as defined 
in terms of amount and quality. He has nowhere suggested the unit 
of nominal value which the analysis requires. 



OTHER THEORIES OF INTEREST 



137 



chosen quite at random and varied by the reader at will, 
for our proposition maintains its validity in every con- 
ceivable position of subjective valuations. Moreover I 
intentionally take figures varying very greatly and ir- 
regularly, it being obvious enough, without any special 
demonstration, that, if the value of the unit of goods 
were not to vary for the different periods, or not to vary 
much, the present means of production, as giving a 
greater quantity of products, would inevitably give us 
also a greater sum of value. Assume, then, quite at 
random, that, for a certain individual, the true marginal 
utility and value of the unit of product — taking into 
account his special circumstances of provision which we 
shall suppose are, on the whole, gradually improving — 
are as follows : in 1888, 5 units of value (pounds, shil- 
lings, or units of any ideal standard) ; in 1889, 4 ; in 
1890, 3.3; in 1891, 2.5; in 1892, 2.2; in 1893, 2.1; in 
1894, 2; and in 1895, i-5- This true marginal utility, 
then, by reason of perspective, experiences, for the later 
periods, an irregularly progressive reduction of this 
kind : for 1888 it is, subjectively estimated, 5 (without 
reduction); for 1889, instead of 4, it is 3.8; for 1890, 
instead of 3.3, it is only 3 ; for 1891, 2.2 ; for 1892, 2 ; 
for 1893, i-Sj fc>r 1894, 1.5; and for 1895, i- If? now, 
on the basis of these figures, we calculate the sums of 
value represented by the different possible products of a 
month's labour falling due in the various years, from 
1888 to 1891, we get the following tables : — 



138 



A THEORY OF INTEREST 



A Month's Labour Available in i 



Yields 



For the 

Economic 

Period 


Units of 
Product 


True Marginal 

Utility of 

Unit 


Marginal 

Utility 
reduced in 
Perspective 


Amount of 

Value of 

Entire 

Product 


1888 
1889 
1890 
1891 
1892 

1893 
1894 

1895 


100 
200 

280 

350 
400 
440 
470 
500 


5 

4 

3-3 

2.5 

2.2 

2.1 

2 

1-5 


5 
3-8 

3 

2.2 
2 
1.8 

1-5 

I 


500 
760 
840 
770 
800 
792 

705 
500 



A Month's Labour Available in 1889 Yields 



For 




True 


Reduced 




Economic 


Units 


Marginal 


Marginal 


Value 


Period 




Utility 


Utility 




1888 




5 


5 




1889 


100 


4 


3-8 


380 


1890 


200 


3-3 


3 


600 


1891 


280 


2-5 


2.2 


616 


1892 


350 


2.2 


2 


700 


1893 


400 


2.1 


1.8 


720 


1894 


440 


2 


1-5 


660 


1895 


470 


i-S 


I 


470 



OTHER THEORIES OF INTEREST 



139 



A Month's Labour Available in 1890 Yields 



For 




True 


Reduced 




Economic 


Units 


Marginax 


Marginal 


Value 


Period 




Utility 


Utility 




1888 




5 


5 




1889 




4 


3-8 




1890 


100 


3-3 


3 


300 


1891 


200 


2-5 


2.2 


440 


1892 


280 


2.2 


2 


560 


1893 


350 


2.1 


1.8 


630 


1894 


400 


2 


1-5 


600 


1895 


440 


1-5 


I 


440 



A Month's Labour Available in 1891 Yields 



For 




True 


Reduced 




Economic 


Units 


Marginal 


Marginal 


Value 


Period 




Utility 


Utility 




1888 





5 


S 




1889 




4 


3.8 




1890 




3-3 


3 




1891 


100 


2.5 


2.2 


220 


1892 


200 


2.2 


2 


400 


1893 


280 


2.1 


1.8 


504 


1894 


350 


2 


i-S 


525 


189s 


400 


1-5 


I 


400 



I40 A THEORY OF INTEREST 

''The conclusion we draw from these tables is the 
following. The highest value of product obtainable by 
the month's labour available in 1888 — that which deter- 
mines its own valuation — is 840 : the highest value 
obtainable by a month's labour available in 1889 is only 
720 : while the highest value obtainable by a month's 
labour available in 1890 and 1891 is 630 and 525 respec- 
tively. As a fact, therefore, the present month's labour 
is superior to all future ones, not only in technical pro- 
ductiveness, but also in marginal utility and value. 

"I repeat emphatically that this result is not an 
accidental one, such as might have made its appearance 
in consequence of the particular figures used in our 
hypothesis. ON THE SINGLE ASSUMPTION 
THAT LONGER METHODS OF PRODUCTION 
LEAD GENERALLY TO A GREATER PRODUCT, 
IT IS A NECESSARY RESULT; a result which must 
have occurred, in an exactly similar way, whatever 
might have been the figures of quantity of product and 
value of unit in the different years. 

' ' I must, further, lay particular weight on the fact, that 
THIS RESULT DOES NOT MAKE ITS APPEAR- 
ANCE SIMPLY BECAUSE, IN OUR HYPOTH- 
ESIS, WE HAVE INTRODUCED, AS ALREADY 
ACTIVE, THOSE OTHER TWO CIRCUMSTANCES 
WHICH ARE FITTED TO ACCOUNT FOR A SUR- 
PLUS VALUE OF PRESENT AS AGAINST FU- 
TURE GOODS — NAMELY, A DIFFERENCE IN 
THE CIRCUMSTANCES OF PROVISION AT THE 
VARIOUS PERIODS OF TIME, AND A DIMINU- 
TION OF THE FUTURE UTILITY BY WAY OF 



OTHER THEORIES OF INTEREST 



141 



PERSPECTIVE. THE SUPERIORITY IN VALUE 
OF PRESENT MEANS OF PRODUCTION, WHICH 
IS BASED ON THEIR TECHNICAL SUPERIORITY, 
IS NOT ONE BORROWED FROM THESE CIRCUM- 
STANCES; IT WOULD EMERGE OF ITS OWN 
STRENGTH EVEN IF THESE WERE NOT ACTIVE 
AT ALL. I have introduced the two circumstances 
into the hypothesis only to make it a httle more true 
to Hfe, or, rather, to keep it from being quite absurd. 
Take, for instance, the influence of the reduction due 
to perspective entirely out of the illustration, and we 
get the following figures : — - 

A Month's Labour of the Year 



Yields for the 
Economic 
Period 



1888 
1889 
i8go 
1891 
1892 

1893 
1894 

1895 



1888 


1889 


1890 


1891 


500 








800 


400 






924 


660 


330 




875 


700 


500 


250 


880 


770 


616 


440 


924 


840 


735 


588 


940 


880 


800 


700 


750 


705 


660 


600 



Units of Value 



"We see that now the absolute figures of the sums of 
value are increased throughout, and also that the 
economic centre of gravity is transferred to another 
year ; but the thing which concerns us is that the result 
remains unchanged ; — the month's labour of 1888 shows 
the highest figure of value, and all the others a decreas- 
ingly smaller one. 

"But if we were also to abstract the difference in the 



142 A THEORY OF INTEREST 

circumstances of provision in different periods of time, 
the situation would receive the stamp of extreme im- 
probabiHty, even of self-contradiction. If the value of 
the unit of product were to be the same in all periods of 
time, however remote, the most abundant product 
would, naturally, at the same time be the most valu- 
able. But since the most abundant product is obtained 
by the most lengthy and roundabout methods of pro- 
duction, — - perhaps extending over decades of years, — ■ 
the economic centre of gravity, for all present means of 
production, would, on this assumption, be found at 
extremely remote periods of time — which is entirely 
contrary to all experience. And, besides, if such a 
state of things were to emerge at any particular point 
of time, it would immediately bring its own correction. 
For if every employment of goods for future periods is, 
not only technically, but economically, more remunera- 
tive than the employment of them for the present or 
near future, of course men would withdraw their stocks 
of goods, to a great extent, from the service of the 
present, and direct them to the more remunerative 
service of the future. But this would immediately 
cause an ebb-tide in the provision for the present, and 
a flood in the provision for the future, for the future 
would then have the double advantage of having a 
greater amount of productive instruments directed to its 
service, and those instruments employed in more fruitful 
methods of production. Thus the difference in the cir- 
cumstances of provision, which might have disappeared 
for the moment, would recur of its own accord. 

''But it is just at this point that we get the best 



OTHER THEORIES OF INTEREST 



143 



proof that the superiority in question is independent of 
differences in the circumstances of provision : so far 
from being obhged to borrow its strength and activity 
from any such difference, it is, on the contrary, able, if 
need be, to call forth this very difference. — Thus we 
get, as result of our digression, the assured conviction 
of two things ; — first, that THE PRODUCTIVE SU- 
PERIORITY OF PRESENT GOODS ASSURES 
THEM, NOT ONLY A SURPLUS IN PRODUCT, 
BUT A SURPLUS IN VALUE, and, second, that, IN 
THIS SUPERIORITY, WE HAVE TO DEAL WITH 
A THIRD CAUSE OF THE SURPLUS VALUE, 
AND ONE WHICH IS INDEPENDENT OF ANY 
OF THE TWO ALREADY MENTIONED:' ^ 

*'We have seen that there are three factors, each of 
which, INDEPENDENTLY OF THE OTHER, is 
adequate to account for a difference in value between 
present and future goods in favour of the former. These 
three factors are : The difference in the circumstances 
of provision between present and future; the under- 
estimate, due to perspective, of future advantages and 
future goods ; and, finally, the greater fruitfulness of 
lengthy methods of production." ^ 

The error betrayed in the passages I have printed in 
italic capitals is that of inferring that because, for ex- 
ample, a month's labor of 1888 results in more ''units 

1 The passage here quoted is all except the last two pages of Bohm- 
Bawerk's chapter on The Technical Superiority of Present Goods. 
I quote so fully because this work of Bohm-Bawerk's is out of print 
and not easily accessible to some who may read this book. 

2 This paragraph is from p. 273 of Bohm-Bawerk's Positive Theory 
of Capital. 



144 A THEORY OF INTEREST 

of product" for the year i8go than a month's labor of 
1889 does, the former must be the more valuable. It is 
revealed at once by saying that a month's labor of 1889 
can be employed in a two-year process, in a ten-year 
process, or in a process of any duration you please, just 
as well as a month's labor of 1888 could. Of course, 
Professor Bohm-Bawerk would reply, but the labor of 
1888, employed in a two-year process, would yield the 
product in i8go, whereas that of 1889, employed in a 
process of the same duration, would yield the product 
in i8gi. Well, I rejoin, what of it? You must not 
assume that the product of 1890 is more valuable than 
a product exactly equal (either in your sense of " quantity 
and kind" or in mine of "nominal value") except that 
it is of 1891 ; for that would he assuming, as an essential 
part of your explanation, quite all that you are trying in 
your hook to explain. You are trying to explain why 
"present goods" are more valuable than "future goods" ; 
but without assuming just that as true, your whole 
attempt to connect the superiority of long over short 
processes of production with the premium that "present 
goods" command over "future goods" fails. "Future 
goods," I repeat, may he used in as long processes of pro- 
duction as ^^ present goods ^\- and the fact that, if the 
processes are of equal length, the product will appear 
later in the case of the "future goods," is nothing against 
the "future goods" unless you assume quite all that we 
are trying to explain. 

§ 83. To see the fallacy from another point of view, 
consider the passages in italic capitals in the third para- 
graph above, which expresses the fallacious conclusion 



OTHER THEORIES OF INTEREST 145 

itself very explicitly. "The productive superiority," 
says Bohm-Bawerk, "of present goods assures them, 
not only a surplus in product, but a surplus in value, and, 
second, ... in this superiority we have to deal with a 
third cause of the surplus value, and one which is inde- 
pendent of any of the two already mentioned." As 
future goods can be employed in a productive process 
of any length you please, just as present goods can, the 
only superiority of present goods over future goods of equal 
nominal value ^ is a superiority in value to particular per- 
sons or groups of persons; and that superiority, so far 
from being independent of the first and second of the 
three causes of interest enumerated by Bohm-Bawerk, 
is dependent, as we have seen, on nothing whatever but 
those two causes. It is only because the wants of any 
particular person or groups of persons are in fact de- 
creasing, relatively to those of the society contemporary 
with each moment of the passing time, and because the 
estimate of that relative decrease of their wants, as 
made by the persons concerned, may be exaggerated, 
that present goods have for those persons a value greater 
than that of future goods equal to them in nominal 
value. Bohm-Bawerk's supposed third cause of in- 
terest, therefore, which he regards as the "chief pillar" 
of his theory, cannot stand the test of critical analysis. 
"Present goods" have no technical superiority over 
"future goods." The superiority of present goods over 
those future goods with which they are to be compared 
in the analysis of the interest problem, namely future 

^ I abandon Bohm-Bawerk's conception of the principal for my own, 
because I assume that the reader is no longer in doubt on that point. 



146 A THEORY OF INTEREST 

goods of the same nominal value, is not a technical su- 
periority at all, but the same value-to-particular-persons- 
superiority that was mistaken by the upholders of the 
*' productivity theory," whom Bohm-Bawerk scorned, 
for superiority in productivity. So far as this ''chief 
pillar" is concerned, indeed, Bohm-Bawerk's theory, 
original as it appeared in the new setting and the brilliant 
treatment given it by him, is nothing whatever, essen- 
tially, but the old productivity theory decked out in 
new errors. Although, like the theorists of the produc- 
tivity school, in which also some distinguished economists 
are still to be numbered, Bohm-Bawerk saw the impor- 
tance for the theory of interest of the two undoubted facts, 
first, that there remain open persistently opportunities 
to secure a nominal surplus by embodying services in 
advances to nature, and, secondly, that the amount of 
this nominal surplus corresponds to the time dimension 
as well as to the other dimensions of the advance to 
nature necessary in the case, he failed as completely as 
did the productivity theorists to build those facts cor- 
rectly into a theory of interest. 

"Productivity" 

§ 84. That the usefulness of tools does not account 
for the premium that ''present goods" command over 
"future goods" has been demonstrated unanswerably by 
Bohm-Bawerk ^ and many others. And the validity of 
some of these demonstrations, including that of Bohm- 
Bawerk, is not in the least degree affected by substituting 

^ Notably, for example, on p. 139 of his Capital and Interest, trans- 
lated by Smart : Macmillan & Co., London, 1890. 



OTHER THEORIES OF INTEREST 147 

for the vague ''present goods" and ''future goods" used 
by writers generally hitherto words that express the 
conception of principal correctly and explicitly. It is 
unnecessary, therefore, for me to devote much space to 
this point. "Why," asks Bohm-Bawerk on page 139 
of his Capital and Interest^ "should a concrete capital 
that yields a great return not be highly valued on that 
account — so highly that its capital value would be 
equal to the value of the abundant return that flows 
form it? Why, e.g., should a boat and net which, 
during the time that they last, help to procure an extra 
return of 2700 fish, not be considered exactly equal in 
value to these 2700 fish? But in that case — in all 
physical productivity — there would be no surplus 
value." To this there is no answer. 

What, then, is the true connection between productiv- 
ity, in the sense of the usefulness of tools, and the 
premium which present services command over future 
services of the same nominal value ? This question I 
have really answered already, but it will do no harm to 
answer it again and more fully. 

In the first place what, precisely, do we mean by the 
usefulness or productivity of tools ? We mean that 
under certain circumstances the locking up for a time of 
human services, that is, labor, in that part of the store- 
house of nature's causal nexus which we might call the 
laws of chemistry and physics, results in the receipt with 
the passage of time, from or through the tools in which 
the services are locked up, of services nominally more 
valuable than the services locked up would have been if 
rendered immediately instead of being thus locked up. 



148 A THEORY OF INTEREST 

To say the same thing more briefly, we mean that, up 
to a certain point which in fact has never been reached, 
labor, to have its utmost value from the point of view of 
the society of the passing time, must be employed in 
processes requiring considerable time before its enjoy- 
able services accrue and must be embodied during that 
considerable time in ''intermediate products" ^ some of 
which are called tools. 

§ 85. We may now consider what is the true con- 
nection between productivity, thus conceived, and the 
premium which present services command over future 
services of the same nominal value. It is this : produc- 
tivity, so far from being the cause of the premium men- 
tioned, is itself caused by the premium. That oppor- 
tunities to secure a nominal surplus by making advances 
to nature still remain open, in other words that an 
additional tool is still ''productive," is due to the fact 
that particular persons or groups of persons, who are 
the only ^ agents that could have eliminated the oppor- 
tunity by making an additional advance to nature, have 
been prevented from doing so by the fact that present 
services were more valuable to them than future services 
of the same nominal value. 

1 This is Bohm-Bawerk's term. See p. 22 of The Positive Theory of 
Capital. 

2 As we have seen, the indispensable condition of taking advantage 
of one of these opportunities is making an advance to nature, locking 
up services for a time in the storehouse of nature's causal nexus ; the in- 
dispensable condition of making an advance an advance is an ad- 
vancer; and the advancer cannot be the "changing society," but must 
be a particular person or group of persons. 



OTHER THEORIES OF INTEREST 149 



"Abstinence" 

§ 86. Many writers, notably Senior/ regard absti- 
nence as the key to the persistence of interest. The fol- 
lowing passages will give an understanding of Senior's 
views on this point. 

^' Instruments of Production^' 

'^ Having explained the nature of Production and 
Consumption, we now proceed to consider the Agents 
by whose intervention Production takes place. 

"I. Labour. — The primary Instruments of Produc- 
tion are Labour, and those Agents of which nature, un- 
aided by man, affords us the assistance. 

"Labour is the voluntary exertion of bodily or mental 
faculties for the purpose of Production. It may appear 
unnecessary to define a term having a meaning so pre- 
cise and so generally understood. Peculiar notions re- 
specting the causes of value have, however, led some 
Economists to employ the term labour in senses so dif- 
ferent from its common acceptation, that for some time 
to come it will be dangerous to use the word without 
explanation. We have already observed that many 
recent writers have considered value as solely dependent 
on labour. When pressed to explain how wine in a cellar, 
or an oak in its progress from a sapling to a tree, could, 
on this principle, increase in value, they repHed that 
they considered the improvement of the wine and the 
growth of the tree as so much additional labour bestowed 

^ Political Economy, second ed., London, 1850. 



150 A THEORY OF INTEREST 

on each. We do not quite understand the meaning of 
this reply; but we have given a definition of labour, 
lest we should be supposed to include in it the unassisted 
operations of nature. It may also be well to remind 
our readers that this definition excludes all those exer- 
tions which are not intended, immediately or through 
their products, to be made the subjects of exchange. 
A hired messenger and a person walking for his amuse- 
ment, a sportsman and a gamekeeper, the ladies at an 
English ball and a company of Natch girls in India, 
undergo the same fatigues ; but ordinary language does 
not allow us to consider those as undergoing labour who 
exert themselves for the mere purpose of amusement. 

''II. Natural Agents. ^ — ^ Under the term 'the 
Agents offered to us by nature,' or, to use a shorter ex- 
pression, 'Natural Agents,' we include every productive 
agent so far as it does not derive its powers from the act 
of man. 

"The term 'Natural Agent' is far from being a con- 
venient designation, but we have adopted it partly 
because it has been already made use of in this sense 
by eminent writers, and partly because we have not 
been able to find one less objectionable. The principal 
of these agents is the land, with its mines, its rivers, its 
natural forests with their wild inhabitants, and, in short, 
all its spontaneous productions. To these must be 
added the ocean, the atmosphere, light and heat, and 
even those physical laws, such as gravitation and elec- 
tricity, by the knowledge of which we are able to vary 
the combinations of matter. All these productive agents 
have in general, by what appears to be an inconvenient 



OTHER THEORIES OF INTEREST 151 

synecdoche, been designated by the term ' land ' ; partly 
because the land, as a source of profit, is the most im- 
portant of those which are susceptible of appropriation, 
but chiefly because its possession generally carries with 
it the command over most of the others. And it is to 
be remembered that, though the powers of nature are 
necessary to afford a substratum for the other instru- 
ments of production to work upon, they are not of them- 
selves, when universally accessible, causes of value. 
Limitation in supply is, as we have seen, a necessary 
constituent of value ; and what is universally accessible 
is practically imlimited in supply. 

''III. Abstinence. — But although Human Labour, 
and the Agency of Nature, independently of that of 
man, are the primary Productive Powers, they require 
the concurrence of a Third Productive Principle to give 
to them complete efficiency. The most laborious popu- 
lation, inhabiting the most fertile territory, if they de- 
voted all their labour to the production of immediate 
results, and consumed its produce as it arose, would soon 
find their utmost exertions insufficient to produce even 
the mere necessaries of existence. 

''To the Third Principle, or Instrument of Produc- 
tion, without which the two others are inefficient, we 
shall give the name of Abstinence : a term by which we 
express the conduct of a person who either abstains 
from the unproductive use of what he can command, or 
designedly prefers the production of remote to that of 
immediate results. 

"It was to the effects of this Third Instrument of 
Production that we adverted, when we laid down, as 



152 A THEORY OF INTEREST 

the third of our elementary propositions, that the 
Powers of Labour and of the other Instruments which 
produce Wealth may be indefinitely increased by using 
their Products as the means of further Production. All 
our subsequent remarks on abstinence are a develop- 
ment and illustration of this proposition; we say de- 
velopment and illustration, because it can scarcely be 
said to require formal proof. 

''The division of the Instruments of Production into 
three great branches has long been familiar to Economists. 
Those branches they have generally termed Labour, 
Land, and Capital. In the principle of this division we 
agree ; though we have substituted different expres- 
sions for the second and third branches. We have pre- 
ferred the term Natural Agents to that of Land, to 
avoid designating a whole genus by the name of one of 
its species : a practice which has occasioned the other 
cognate species to be generally slighted and often for- 
gotten. We have substituted the term 'Abstinence' 
for that of Capita] on different grounds. 

"The term 'Capital' has been so variously defined 
that it may be doubtful whether it have any generally 
received meaning. We think, however, that, in popular 
acceptation, and in that of Economists themselves, when 
they are not reminded of their definitions, that word 
signifies an article of wealth, the result of human exer- 
tion, employed in the production or distribution of wealth. 
We say the result of human exertion, in order to exclude 
those productive instruments to which we have given 
the name of natural agents, and which afford not profit, 
in the scientific sense of that word, but rent. 



OTHER THEORIES OF INTEREST 153 

''It is evident that Capital, thus defined, is not a 
simple productive instrument; it is in most cases the 
result of all the three productive instruments combined. 
Some natural agent must have afforded the material, 
some delay of enjoyment must in general have reserved 
it from unproductive use, and some labour must in 
general have been employed to prepare and preserve it. 
By the word Abstinence, we wish to express that agent, 
distinct from labour and the agency of nature, the con- 
currence ofn which is necessary to the existence of Capital, 
and which stands in the same relation to Profit as Labour 
does to Wages. We are aware that we employ the word 
Abstinence in a more extensive sense than is warranted by 
common usage. Attention is usually drawn to absti- 
nence only when it is not united with labour. It is 
recognized instantly in the conduct of a man who allows 
a tree or a domestic animal to attain its full growth ; 
but it is less obvious when he plants the sapling or sows 
the seed corn. The observer's attention is occupied by 
the labour, and he omits to consider the additional 
sacrifice made when labour is undergone for a distant 
object. This additional sacrifice we comprehend under 
the term Abstinence; not because Abstinence is an 
unobjectionable expression for it, but because we have 
not been able to find one to which there are not still 
greater objections. We once thought of using 'provi- 
dence ' ; but providence implies no self-denial, and has 
no necessary connection with profit. To take out an 
umbrella is provident, but not in the usual sense of the 
word profitable. We afterwards proposed 'frugality,' 
but frugality implies some care and attention, that is to 



154 



A THEORY OF INTEREST 



say, some labour ; and though in practice Abstinence is 
almost always accompanied by some degree of labour, 
it is obviously necessary to keep them separate in an 
analysis of the instruments of production. 

"It may be said that pure Abstinence, being a mere 
negation, cannot produce positive effects; the same 
remark might as well be appHed to intrepidity, or even 
to liberty; but who ever objected to their being con- 
sidered as equivalent to active agents? To abstain 
from the enjoyment which is in our power, or to seek 
distant rather than immediate results, are among the 
most painful exertions of the human will. It is true 
that such exertions are made, and indeed are frequent 
in every state of society, except perhaps in the very 
lowest, and have been made in the very lowest, for society 
could not otherwise have improved ; but of all the means 
by which man can be raised in the scale of being, ab- 
stinence, as it is perhaps the most effective, is the slowest 
in its increase, and the least generally diffused. Among 
nations, those that are the least civiHzed, and among 
the different classes of the same nation those which are 
the worst educated, are always the most improvident, 
and consequently the least abstinent. 

''Capital. — We have already defined Capital to be 
an article of wealth, the result of human exertion, em- 
ployed in the production or distribution of wealth, and 
we have observed that each individual article of capital 
is in general the result of a combination of all the three 
great instruments of production — labour, abstinence, 
and the agency of nature." ^ 

^ Work cited, pp. 57-60. 



OTHER THEORIES OF INTEREST 



155 



^'In the second class we have the words Capital, 
Capitalist, and Profit. These terms express the instru- 
ment, the person who employs or exercises it, and his 
remuneration ; but there is no familiar term to express 
the act, the conduct of which profit is the reward, and 
which bears the same relation to profit which labour 
does to wages. To this conduct we have already given 
the name of Abstinence. The addition of this term will 
complete the nomenclature of the second class. Capital 
is an article of wealth, the result of human exertion, 
employed in the production or distribution of Wealth. 
Abstinence expresses both the act of abstaining from the 
unproductive use of capital, and also the similar conduct 
of the man who devotes his labour to the production of 
remote rather than of immediate results. The person 
who so acts is a Capitalist, the reward of his conduct is 
Profit." 1 

"We have seen that Profit is the remuneration of 
abstinence, and that abstinence is the deferring of 
enjoyment." ^ 

§ 87. It is clear from the second passage quoted that 
what Senior terms "Profit" is what we nowadays term 
"interest." Interest, therefore, according to Senior, 
is that part of the income of society which is produced 
by "abstinence"; and it is therefore equitable that it 
should be received, as it is received, by members of 
society in proportion to their practice of "abstinence." 

To what extent is this true ? 

The word "abstinence," in the first place, is not quite 

1 Work cited, p. 89. 

2 Work cited, p. 185. 



156 A THEORY OF INTEREST 

the best one for the 'deferring of enjoyment" which it 
is made by Senior to cover. Abstinence suggests going 
without the consumption in question altogether rather 
than merely deferring it. It lent itself readily, there- 
fore, to the attacks of such men as Lassalle.^ ''The 
profit of capital," exclaims Lassalle, ''is the 'wage of 
abstinence.' Happy, even priceless expression ! The 
ascetic millionaires of Europe ! Like Indian penitents 
or pillar saints they stand : on one leg, each on his 
column, with straining arm and pendulous body and 
pallid looks, holding a plate towards the people to col- 
lect the wages of their Abstinence. In their midst, 
towering up above all his fellows, as head penitent and 
ascetic, the Baron Rothschild ! This is the condition 
of society ! how could I ever so much misunderstand 
it!" 

Better than the word "abstinence" is one suggested 
by Professor Silas Macvane in the Quarterly Journal of 
Economics for July, 1887, and adopted by Marshall and 
others since, the word " waiting." The deferring of con- 
sumption which is certainly involved, as Senior and some 
of his predecessors saw clearly, in the receipt by society 
of the surplus we call interest, is fully covered by the 
word " waiting " ; and yet that word does not imply, as 
the word "abstinence" does, any diminution in aggregate 
consumption. 

Suppose the word " waiting " substituted for the word 

^ Lassalle's attacks on abstinence as a justification for the receipt 
of interest by capitalists appeared in Kapital und Arbeit, Berlin, 1864, 
according to Bohm-Bawerk's Capital and Interest, p. 276, from which 
I quote the passage from Lassalle in the text. 



OTHER THEORIES OF INTEREST 157 

'' abstinence " : what is then to be said of Senior's theory ? 
The theory would then be true so far as it goes, but it 
would be inadequate. It is true that waiting or advanc- 
ing is an indispensable condition of gaining the (nominal) 
surplus called interest. It is also equitable that who- 
ever supplies this indispensable condition of the nominal 
surplus should be the one to receive the nominal surplus, 
or that every one should receive the nominal surplus 
that he has produced by his waiting or advancing.^ 
But no theory is adequate to account for interest that 
does not explain just why the supply of waiting fails, 
age after age, to equal the demand at a price lower 
than about 3 per cent of the principal. If waiting pro- 
duces a surplus and the surplus goes to those who wait, 
why do men set a limit to their waiting before they have 
exhausted all the opportunities to secure the surplus? 
Are the causes of the setting of this Hmit where it is set 
rational, or irrational, or both? And what are they? 
These questions — to say nothing of others that no 
economist could have been expected to answer, or even 
to ask, in Senior's time ^ Senior did not answer. On 
the whole Senior's theory is to be regarded as a well- 
constructed theory essentially true so far as it went. 

Productivity and Waiting 

§ 88. Some recent writers, notably Professor T. N. 
Carver, explain interest somewhat as Senior did, except 
that they use the better word ''waiting" instead of "ab- 
stinence" and that they explain the causal connection be- 
tween ''productivity" and men's dislike of waiting, 
^ On this point see also § 90 below. 



158 A THEORY OF INTEREST 

making use, in connection with productivity, of the sig- 
nificant conception of the margin brought into economic 
theory by Gossen,^ Jevons,^ Carl Menger,^ Walras,^ and 
others.^ Pages 219-232 of Professor Carver's Distribu- 
tion of Wealth^ may be referred to as showing clearly this 
considerable advance beyond the theory of Senior. 

Even in the hands of so recent and so able a writer 
as Carver, however, the problem of interest is not quite 
solved. Like all his predecessors, as it seems to me, 
Carver fails to discover the true conception of the prin- 
cipal, without which there can be no true conception of 
the surplus above principal that is called interest and 
consequently no satisfactory analysis of the whole 
problem. At times, to be sure, as on page 226, where 
he says that capital's "earning or its marginal produc- 
tivity would, during its lifetime, just cover its cost," 
he appears to conceive the principal in terms of value 
and cost instead of in terms of amount and quality; 
but for the most part the amount and quality conception 
satisfies him.^ 

^H. H. Gossen: Entwickelung der Gesetze des menschlichen Verkehrs, 

1854. 

2 W. S. Jevons : Theory of Political Economy, first ed. 1871. 

3 Carl Menger : Grundsdtze der Volkswirthschaftslehre, 1871. 
^ Leon Walras : Elements d' Economic Pure, 1874. 

^ For a detailed account of the history of the doctrine of marginal 
utility see a note on pp. 78 and 79 of Bruce's translation of M. 
Pantaleoni's Pure Economics, London, Macmillan, 1898. 

^ New York, The Macmillan Co., 1904. 

^ See, for example, these expressions: "more" and "amount" 
(p. 129); "total product," "amount," "more work," "largest product," 
"maximum per man," and "maximum per loom" (p. 220); "more," 
"less," "amount," and "larger number of plows" (p. 221). It is with 



OTHER THEORIES OF INTEREST 



159 



"Exploitation" 

§ 89. Some writers, of whom Karl Marx has in- 
fluenced the largest number of persons, have explained 
interest as due to the exploitation of employees by their 
employers. Marx's theory, developed in full in his 
work. Das Kapital, is expressed briefly also in the fol- 
lowing passages quoted from a paper ^ read by him 
before the General Council of the International Work- 
ingmen's Association in 1865. The italics are those of 
the Century Press edition. 

Labour Power 

*' Having now, as far as it could be done in such a 
cursory manner, analysed the nature of Value, of the 
Value of any commodity whatever, we must turn our 
attention to the specific Value of Labour. And here, 
again, I must startle you by a seeming paradox. All of 
you feel sure that what you daily sell is your Labour; 
that, therefore. Labour has a Price, and that, the price 
of a commodity being only the monetary expression of 
its value, there must certainly exist such a thing as the 
Value of Labour. However, there exists no such thing 
as the Value of Labour in the common acceptance of the 
word. We have seen that the amount of necessary 
Labour crystallised in a community constitutes its value. 

such terms as these, and without the use of those covering any sort of 
value, that Carver explains "marginal productivity." As we have seen, 
productivity can be explained correctly only in terms of value. 

^ Published under the title of Value, Price, and Profit by the Twen- 
tieth Century Press, London, 1908. The passage quoted is from pp. 
28-35- 



l6o A THEORY OF INTEREST 

Now, applying this notion of value, how could we 
define, say, the value of a ten hours' working day? 
How much labour is contained in that day ? Ten hours' 
labour. To say that the value of a ten hours' working 
day is equal to ten hours' labour, or the quantity of 
labour contained in it, would be tautological, and, more- 
over, a nonsensical expression. Of course, having once 
found out the true hidden sense of the expression ' Value 
of Labour,^ we shall be able to interpret this irrational, 
and seemingly impossible application of value, in the 
same way that, having once made sure of the real move- 
ment of the celestial bodies, we shall be able to explain 
their apparent or merely phenomenal movements. 

"What the workingman sells is not directly his 
Labour, but his Labour power, the temporary disposal of 
which he makes over to the capitaHst. This is so much 
the case that — I do not know whether by the English 
laws, but certainly by some Continental laws — the 
maximum time is fixed for which a man is allowed to 
sell his labour power. If allowed to do so for any in- 
definite period whatever, slavery would be immediately 
restored. Such a sale, if it comprised his lifetime, for 
example, would make him at once the lifelong slave of 
his employer. 

"One of the oldest economists and most original 
philosophers of England — Thomas Hobbes — has al- 
ready, in his 'Leviathan,' instinctively hit upon this 
point overlooked by all his successors. He says : ' The 
value or worth of a man is, as in all other things, his 
price — that is, so much as would be given for the Use 
of his Power. ^ 



OTHER THEORIES OF INTEREST i6l 

"Proceeding from this basis, we shall be able to deter- 
mine the Value of Labour as that of all other commodities. 

"But before doing so, we might ask, how does this 
strange phenomenon arise, that we find on the market 
a set of buyers possessed of land, machinery, raw ma- 
terial, and the means of subsistence, all of them, save 
land in its crude state, the products of labour, and, on 
the other hand, a set of sellers who have nothing to sell 
except their labour power, their working arms and 
brains ? That the one set buy continually in order to 
make a profit and enrich themselves, while the other 
set continually sell in order to earn their livelihood? 
The inquiry into this question would be an inquiry 
into what the economists call 'Previous or Original 
Accumulation/ but which ought to be called Original 
Expropriation. We should find that this so-called 
Original Accumulation means nothing but a series of 
historical processes, resulting in a Decomposition of the 
Original Union existing between the Labouring Man 
and his Instruments of Labour. Such an inquiry, how- 
ever, lies beyond the pale of my present subject. The 
Separation between the Man of Labour and the Instru- 
ments of Labour once established, such a state of things 
will maintain itself and reproduce itself upon a con- 
stantly increasing scale, until a new and fundamental 
revolution in the mode of production shall again overturn 
it, and restore the original union in a new historical form. 

"What, then, is the Value of Labour Power? 

"Like that of every other commodity, its value is 
determined by the quantity of labour necessary to pro- 
duce it. The labour power of a man exists only in his 

M 



1 62 A THEORY OF INTEREST 

living individuality. A certain mass of necessaries must 
be consumed by a man to grow up and maintain his life. 
But the man, like the machine, will wear out, and must 
be replaced by another man. Besides the mass of 
necessaries required for his own maintenance, he wants 
another amount of necessaries to bring up a certain quota 
of children that are to replace him on the labour market 
and to perpetuate the race of labourers. Moreover, to 
develop his labour power, and acquire a given skill, 
another amount of values must be spent. For our pur- 
pose it suffices to consider only average labour, the costs 
of whose education and development are vanishing mag- 
nitudes. Still I must seize upon this occasion to state 
that, as the costs of producing labour powers of different 
quality differ, so must differ the values of the labour 
powers employed in different trades. The cry for an 
equality of wages rests, therefore, upon a mistake, is an 
insane wish never to be fulfilled. It is an offspring of 
that false and superficial radicalism that accepts premises 
and tries to evade conclusions. Upon the basis of the 
wages system the value of labour power is settled like 
that of every other commodity ; and as different kinds 
of labour powers have different values, or require dif- 
ferent quantities of labour for their production, they 
must fetch different prices in the labour market. To 
clamour for equal or even equitable retribution on the basis 
of the wages system is the same as to clamour for free- 
dom on the basis of the slavery system. What you think 
just or equitable is out of the question. The question 
is : What is necessary and unavoidable with a given 
system of production? 



OTHER THEORIES OF INTEREST 163 

''After what has been said, it will be seen that the 
value of labour power is determined by the value of the 
necessaries required to produce, develop, maintain, and 
perpetuate the labour power. 

Production of Surplus Value 

"Now suppose that the average amount of the daily 
necessaries of a labouring man require six hours of 
average labour for their production. Suppose, moreover, 
six hours of average labour to be also realised in a 
quantity of gold equal to 3s. Then 3s. would be the 
Price, or the monetary expression of the Daily Value of 
that man's Labour Power. If he worked daily six hours 
he would daily produce a value sufficient to buy the 
average amount of his daily necessaries, or to maintain 
himself as a labouring man. 

"But our man is a wages labourer. He must, there- 
fore, sell his labour power to a capitalist. If he sells it 
at 3s. daily, or i8s. weekly, he sells it at its value. Sup- 
pose him to be a spinner. If he works six hours daily 
he will add to the cotton a value of 3s. daily. This 
value, daily added by him, would be an exact equivalent 
for the wages, or the price of his labour power, received 
daily. But in that case, no surplus value or surplus 
produce whatever would go to the capitalist. Here, 
then, we come to the rub. 

''In buying the labour power of the workman, and 
paying its value, the capitalist, like every other pur- 
chaser, has acquired the right to consume or use the 
commodity bought. You consume or use the labour 
power of a man by making him work, as you consume 



164 A THEORY OF INTEREST 

or use a machine by making it run. By buying the 
daily or weekly value of the labour power of the work- 
man, the capitalist has, therefore, acquired the right to 
use or make that labour power work during the whole 
day or week. The working day or the working week has, 
of course, certain limits, but into this we shall afterwards 
look more closely. 

''For the present I want to turn your attention to one 
decisive point. 

"The value of the labour power is determined by the 
quantity of labour necessary to maintain or reproduce 
it, but the use of that labour power is only limited by 
the active energies and physical strength of the labourer. 
The daily or weekly value of the labour power is quite 
distinct from the daily or weekly exercise of that power, 
the same as the food a horse wants and the time it can 
carry the horseman are quite distinct. The quantity 
of labour by which the value of the workman's labour 
power is Kmited, forms by no means a limit to the quan- 
tity of labour which his labour power is apt to perform. 
Take the example of our spinner. We have seen that, 
to daily reproduce his labour power, he must daily re- 
produce a value of three shilhngs, which he will do by 
working six hours daily. But this does not disable him 
from working ten or twelve or more hours a day. But 
by paying the daily or weekly value of the spinner's 
labour power the capitahst has acquired the right of 
using that labour power during the whole day or week. 
He will, therefore, make him work say, daily, twelve 
hours. Over and above the six hours required to replace 
his wages, or the value of his labour power, he will, 



OTHER THEORIES OF INTEREST 165 

therefore, have to work six other hours, which I shall 
call hours of surplus labour, which surplus labour will 
reahse itself in a surplus value and a surplus produce. 
If our spinner, for example, by his daily labour of six 
hours, added three shillings' value of the cotton, a value 
forming an exact equivalent to his wages, he will, in 
twelve hours, add six shilhngs' worth to the cotton, and 
produce a proportional surplus of yarn. As he has sold 
his labour power to the capitahst, the whole value of 
produce created by him belongs to the capitahst, the 
owner pro tem. of his labour power. By advancing three 
shillings, the capitahst will, therefore, reahse a value 
of six shilhngs, because advancing a value in which six 
hours of labour are crystalhsed, he wiU receive in return 
a value in which twelve hours of labour are crystalhsed. 
By repeating this same process daily, the capitahst 
win daily advance three shilhngs and daily pocket six 
shilhngs, one half of which wih go to pay wages anew, 
and the other half of which will form surplus value, for 
which the capitalist pays no equivalent. It is this sort 
of exchange between capital and labour upon which capi- 
tahst production, or the wages system, is founded, and 
which must constantly result in reproducing the work- 
ingman as a workingman, and the capitahst as a capi- 
talist. 

''The rate of surplus value, all other circumstances re- 
maining the same, wiU depend on the proportion between 
that part of the working day necessary to reproduce the 
value of the labour power and the surplus time or surplus 
labour performed for the capitahst. It wiU, therefore, 
depend on the ratio in which the working day is pro- 



1 66 A THEORY OF INTEREST 

longed over and above that extent by which the working- 
man would only reproduce the value of his labour 
power, or replace his wages. 

Value of Labour 

^'We must now return to the expression, ^ Value, or 
Price of Labour.^ 

''We have seen that, in fact, it is only the value of 
the labour power, measured by the values of commodi- 
ties necessary for its maintenance. But since the work- 
man receives his wages after his labour is performed, 
and knows, moreover, that what he actually gives to 
the capitalist is his labour, the value or price of his 
labour power necessarily appears to him as the price or 
value of his labour itself. If the price of his labour power 
is three shillings, in which six hours of labour are realised, 
and if he works twelve hours, he necessarily considers 
these three shilKngs as the value or price of twelve hours 
of labour, although these twelve hours of labour realise 
themselves in a value of six shilHngs. A double conse- 
quence flows from this. 

"Firstly. The value or price of the labour power takes 
the semblance of the price or value of labour itself, al- 
though, strictly speaking, value and price of labour are 
senseless terms. 

"Secondly. Although one part only of the work- 
man's daily labour is paid, while the other part is unpaid, 
and while that unpaid or surplus labour constitutes 
exactly the fund out of which surplus value or profit is 
formed, it seems as if the aggregate labour was paid 
labour. 



OTHER THEORIES OF INTEREST 167 

"This false appearance distinguishes wages labour from 
other historical forms of labour. On the basis of the 
wages system even the unpaid labour seems to be paid 
labour. With the slave, on the contrary, even that part 
of his labour which is paid appears to be unpaid. Of 
■ course, in order to work the slave must live, and one 
part of his working day goes to replace the value of his 
own maintenance. But since no bargam is struck 
between him and his master, and no acts of selling and 
buying are going on between the two parties, all his 
labour seems to be given away for nothing. 

"Take on the other hand, the peasant serf, such as 
he I might say, until yesterday existed in the whole 
East of Europe. This peasant worked, for example 
three days for himself on his own field or the field allotted 
to him, and the three subsequent days he performed 
compulsory and gratuitous labour on the estate of his 
lord Here, then, the paid and unpaid parts of labour 
were sensibly separated, separated in time and space; 
and our Liberals overflowed with moral indignation at 
the preposterous notion of making a man work for 

nothing. , ., 

" In point of fact, however, whether a man works three 
days of the week for himself on his own field and three 
days for nothing on the estate of his lord, or whether 
he works in the factory or the workshop six hours daily 
for himself and six for his employer, comes to the same, 
although in the latter case the paid and unpaid portions 
of labour are inseparably mixed up with each other, and 
the nature of the whole transaction is completely masked 
by the intervention of a contract and the pay received at 



1 68 A THEORY OF INTEREST 

the end of the week. The gratuitous labour appears to 
be voluntarily given in the one instance, and to be com- 
pulsory in the other. That makes all the difference. 

''In using the words ^ value of labour,'' I shall only 
use them as a popular slang term for ^ value of labour 
power.' 

Profit is Made by Selling a Commodity at its 

Value 

"Suppose an average hour of labour to be realised in 
a value equal to sixpence, or twelve average hours of 
labour to be realised in six shilHngs. Suppose, further, 
the value of labour to be three shillings or the produce 
of six hours' labour. If, then, in the raw material, 
machinery, and so forth, used up in a commodity, 
twenty-four hours of average labour were reaHsed, its 
value would amount to twelve shillings. If, moreover, 
the workman employed by the capitalist added twelve 
hours of labour to those means of production, these 
twelve hours would be realised in an additional value of 
six shillings. The total value of the product would, there- 
fore, amount to thirty-six hours of realised labour, and 
be equal to eighteen shillings. But as the value of 
labour, or the wages paid to the workman, would be 
three shillings only, no equivalent would have been paid 
by the capitahst for the six hours of surplus labour worked 
by the workman, and realised in the value of the com- 
modity. By selling this commodity at its value for 
eighteen shilhngs, the capitahst would, therefore, realise 
a value of three shilhngs, for which he had paid no 
equivalent. These three shillings would constitute the 



OTHER THEORIES OF INTEREST 169 

surplus value or profit pocketed by him. The capitahst 
would, consequently, realise the profit of three shilhngs, 
not by selling his commodity at a price over and above 
its value, but by selling it at its real value. 

"The value of a commodity is determined by the 
total quantity of labour contained in it. But part of that 
quantity of labour is reaKsed in a value for which an 
equivalent has been paid in the form of wages ; part of 
it is reaHsed in a value for which no equivalent has been 
paid. Part of the labour contained in the commodity 
is paid labour ; part is unpaid labour. By selling, there- 
fore, the commodity at its value — that is, as the crystal- 
Hsation of the total quantity of labour bestowed upon it, 
the capitalist must necessarily sell it at a profit. He sells 
not only what has cost him an equivalent, but HE SELLS 
ALSO WHAT HAS COST HIM NOTHING, although 
it has cost his workman labour. The cost of the com- 
modity to the capitahst and its real cost are different 
things. I repeat, therefore, that normal and average 
profits are made by selling commodities not above, but 
at their real values. 

The Different Parts into which Surplus Value 

IS Decomposed 

''The surplus value, or that part of the total value of 
the commodity in which the surplus labour or unpaid 
labour of the workingman is reahsed, I call Profit. The 
whole of that profit is not pocketed by the employing 
capitalist. The monopoly of land enables the land- 
lord to take one part of that surplus value, under the 
name of rent, whether the land is used for agricultural 



lyo A THEORY OF INTEREST 

buildings or railways, or for any other productive pur- 
pose. On the other hand, the very fact that the pos- 
session of the instruments of labour enables the employ- 
ing capitalist to produce a surplus value, or, what comes 
to the same, to appropriate to himself a certain amount of 
unpaid labour, enables the owner of the means of labour, 
which he lends wholly or partly to the employing capi- 
tahst — enables, in one word, the money-lending capi- 
talist to claim for himself under the name of interest 
another part of that surplus value, so that there remains 
to the employing capitalist as such only what is called 
industrial or commercial profit. 

"By what laws this division of the total amount of 
surplus value amongst those three categories of people 
is regulated, is a question quite foreign to our subject. 
This much, however, results from what has been stated. 

'^Rent, Interest, and Industrial Profit are only different 
names for different parts of the surplus value of the com- 
modity, or the unpaid labour enclosed in it, and they are 
equally derived from this source, and from this source 
alone. ^' 

§ 90. This theory, the exploitation theory as it is 
usually called, is erroneous in its main tenets. Its 
prime error, which vitiates the whole argument above 
and a large part of the whole Marxian philosophy, is the 
assumption that although competition would reduce the 
wages of laborers to equahty with the cost of reproduc- 
ing the laborers, it would not reduce the price of the 
product to the cost of producing it. In the absence of 
monopoly — and monopoly is not necessarily involved 
in Marx's theory — competition among employers would 



OTHER THEORIES OF INTEREST 171 

cut the price of the commodities or services produced 
by each employee from six shillings down, down, until 
in the case of the marginal employer, that is, the em- 
ployer to whom it was barely worth while to continue 
producing, it was just three shilhngs. This is on the 
supposition that no waiting or advancing is required in 
the process of production. Then the only ''profits" left 
to any of the employers would be the difference between 
what each could produce and what the marginal employer 
could produce at the same cost ; and those profits would 
obviously be in the nature of wages for superior directive 
ability. 

But suppose — what is actually the case in virtually 
all modern production — that a considerable nominal 
surplus arises from keeping services to a considerable 
nominal value locked up, during the process of produc- 
tion in question, in the form of buildings, tools, machines, 
horses, office furniture, etc. Then the employers or 
others will be induced to make advances to secure this 
nominal surplus more and more until the (declining) 
value to the advancers of another increment of advances 
ceases to be greater than its (rising) cost to the ad- 
vancers. And those advances will command as a price 
the nominal surplus which at the margin they produce. 
This nominal surplus will be received not at all by em- 
ployers in their capacity of employers, but by advancers 
(savefs, capitalists), whether they happen to be also the 
employers or not. 

If Marx's theory were true, we should find the profits^ 

^ I use the word in the very wide popular sense here, to include rent 
of land, "rent of ability," interest, and wages of management. 



172 A THEORY OF INTEREST 

of manufacturers varying not only with the efhciency 
of their management and with the advantages they may 
have through some degree of monopoly, but also with 
the number of employees they hire, the amount of the 
daily wages they have to pay them, and the length of the 
working day. But we do not find their profits varying 
thus at all : we find them, on the other hand, varying 
with the employer's efficiency of management, with his 
advantages from monopoly, and with the amount of the 
advances, reckoned as I have reckoned them,-^ that he 
or somebody else has to make in order to manufacture 
the products in question with as little cost as possible, 
reckoning the interest on these advances as a cost or as 
the equivalent of a cost. And we find that that ele- 
ment of the manufacturer's profits which is interest, that 
is, nominal surplus due to advancing the principal, goes 
into the pocket of whoever produces it by advancing the 
principal, regardless of whether he employs any wage 
laborers or not. 

"No surplus value or surplus product whatever would 
go to the capitalist," says Marx near the beginning of the 
passage reprinted above, if the capitalist cotton-manu- 
facturer paid his spinners the full value of their contribu- 
tion to the value of the cloth. This, as we have seen, is 
completely erroneous. The capitalist, whether manufac- 
turer also or merely a capitalist who lends to the manufac- 
turer and perhaps holds bonds on the business, can certainly 
secure the nominal surplus called interest even when every 

1 That is, reckoning the amount of an advance as a thing of three 
dimensions ; I think it necessary to warn the reader once more that an 
advance is not to be confused with the services advanced. 



OTHER THEORIES OF INTEREST 173 

wage-earner in the business is paid the full value of what 
he contributes to it. 

It may be replied, of course, that without the coopera- 
tion of labor the capital used in a cotton factory could 
not possibly produce anything of value. But it could 
be rejoined with equal truth that on the other hand with- 
out the advances supplied by the ''capitalists" the labor- 
ers could not produce cotton cloth having more than a 
trifling value in comparison with what they can produce 
with the cooperation of the advancers. It is just as un- 
fair to say that the laborers deserve all the product as 
it is to say that the advancers (capitalists) deserve nearly 
all of it. The reasonable view is that the laborers de- 
serve wages equal to the value of the marginal unit 
of their labor under the conditions of industry actually 
present, wliich is normally ^ just what they get, and that 
the advancers deserve the nominal surplus which the 
marginal unit of their advances creates, which is nor- 
mally just what they get. 

§ 91. If any reader is still in doubt whether Marx's 
theory may not, somehow, be true, let him consider the 
case of a Crusoe on his island before the appearance of 
his man Friday. Even Crusoe alone on his island could 
earn interest by making advances. He frequently has 

1 In the sense of the words " normally " defined in § 18. Usually, of 
course, wage-laborers get less than they would get if normal conditions 
prevailed : private appropriation of socially created values, notably 
those of favored land sites, private appropriation of the monopoly 
element of prices boosted by legal limitation of the freedom of the market 
under the so-called "protective tariff" system, and many less easily 
avoidable aberrations from normal conditions prevent wage-earners 
from receiving what they ought to. 



174 A THEORY OF INTEREST 

occasion, we may suppose, to cross, at the cost of con- 
siderable discomfort, a certain brook. The cost of bridg- 
ing the brook is much greater, let us say, than that of 
crossing it twice — and he will not have occasion to cross 
it more than once during the time required to bridge it 
— but much less than that of crossing it as many times 
as he will have occasion to cross it before the bridge 
wears out or even needs repairs. The case stands, 
then, thus. If he builds the bridge and enjoys the use 
of it for a long time, say until it needs repairs, he makes, 
from the point of view of pleasure and pain, a net loss 
while building the bridge but a net gain in the end. He 
is confronted, therefore, with precisely the same problem 
that confronts the wage worker in a cotton factory who 
considers whether or not he will buy a hundred dollar 
5 % bond issued for the purchase of needed machinery by 
the company for which he is working. If Crusoe invests, 
and uses the bridge long enough, he makes a net gain ; 
but if he invests, and does not use the bridge long enough, 
he makes a net loss. If the wage worker invests, and 
enjoys his $5 a year of interest long enough, he makes 
a net gain ; but if he invests, and does not enjoy the $5 
a year long enough, he makes a net loss. Let us sup- 
pose that each man makes the investment mentioned. 
In doing so each ehminates one of the best remaining 
opportunities to secure a surplus by making an advance 
to nature. Suppose, now, that after a while Crusoe has 
eliminated (by taking advantage of them) so many of 
the opportunities open to him to secure a surplus by 
making advances to nature that the best opportunity 
remaining, though offering him a surplus provided he 



OTHER THEORIES OF INTEREST 175 

enjoys the thing invested in long enough, offers him no 
surplus if he enjoys the thing no longer than he thinks he is 
likely to. At that point Crusoe may quite rationally restrict 
himself to continuing the advances to nature that he has 
made previously, without making any new ones. Sup- 
pose also that the time has come when our wage worker 
finds all opportunities eliminated for making advances 
that can safely be counted on to yield him over 4 % of 
nominal surplus or interest. Then perhaps he will con- 
sider, just as Crusoe did, that to make the best invest- 
ment still open to him, that is, say, to buy a hundred 
dollar bond yielding 4 %, will mean no surplus to him. 
And at that point, like Crusoe, he may cease making new 
advances and rest satisfied with keeping invested what he 
has invested already. 

There is absolutely no essential difference between the 
two cases. The only difference is that the principal — 
that is, the unit above which all is to be counted as sur- 
plus — and the surplus itself are defined, in Crusoe's 
case, in terms of his own pain and pleasure only, whereas 
in the case of the wage worker, who is the capitalist of 
our example, they are defined in terms of the pain and 
pleasure of those persons whose acts, in the market of 
the changing society of the passing time, determine 
nominal values. The surplus arises just the same with 
Crusoe as with the capitalist in society ; its rate is de- 
termined in his case by essentially the same motives, 
which may be wholly rational, as I have supposed in the 
comparison ; and it is really interest as well in the one 
case as in the other. Interest, therefore, is independent of 
the wage system to which Marx supposed it to he due entirely. 



176 A THEORY OF INTEREST 

"The Fallacy of Saving" 

§ 92. Among persons of Socialistic leanings one finds 
a few whose chief tenet in respect to the interest question 
is that it is pernicious to advise people generally to save 
because saving is not socially beneficial and would soon 
cease to be beneficial to the savers themselves if it were 
practised by all. This view is fully set forth by an acute 
writer, Mr. J. M. Robertson, M.P., in a book called The 
Fallacy of Saving} According to that book, if the aggre- 
gate of saving were greater than it is now, the aggregate 
of consumption would necessarily be less; and if con- 
sumption were less, production would have to be less if 
it were not to glut the market. If all this were true, 
Mr. Robertson would be quite right, in my opinion, in 
pleading for "the substitution of an ideal of consump- 
tion for an ideal of parsimony." ^ But is the first condi- 
tion true? Why should more saving necessarily mean 
less consumption? There is no reason whatever. On 
the contrary, the requisite of an increase of consumption 
that is not to require also additional pain in production 
is an increase of saving. The advancing, at the present 
time, of services to the value of over $100,000,000 by 
embodying them in improved channels in the Mississippi 
River and some of its tributaries would result, in the 
opinion of eminent engineers, in the receipt of a nominal 
surplus by somebody in the long run. But advancing, 
as defined in this book, does not differ a whit from sav- 
ing: either, at bottom, is simply exchanging present 

1 London, 1892. 

2 Fallacy of Saving, p. 90. 



OTHER THEORIES OF INTEREST 177 

income for future income, present services for future 
services. And clearly the nominal surplus securable 
by exchanging, in the way mentioned, a present income 
to the value of $100,000,000 for a future income to a 
still greater nominal value makes possible a greater con- 
sumption by society without greater cost. 

Is there any reason why this greater consumption 
without greater cost should cause any glut in the market ? 
None whatever ; it is only when they are restricted by 
the barrier of cost that people do not take and consume 
services offered to them in the market. Furthermore — 
and the point of this remark will be clear to those who 
have read Mr. Robertson's book — the greater consump- 
tion without greater cost that is made possible by saving 
may take the form of better quality, better books, better 
furniture, better music, etc. — just as well as that of 
greater quantity. Which of the two forms the greater 
consumption takes depends simply on the demand, 
which is determined by the taste, of the public who con- 
stitute the market. 

In any community in which investment in future- 
service goods — houses, ships, tools, or what not — 
yields a nominal surplus or interest — and doubtless 
every community in the world answers to this description 
— there is no fallacy at all involved in advising people 
generally to save up to the point where they themselves 
are unlikely, in their estimation, to be benefited by 
further saving. Normally the savings in such a com- 
munity take the form of advances to nature that yield 
the nominal surplus that commonly goes by the name of 
interest. The nominal surplus thus yielded is, from the 



lyS A THEORY OF INTEREST 

point of view of the changing society of the community, 
all net gain ; and from the point of view of the individual 
savers it is partly net gain except in the case of the very 
marginal unit of it. 

"Fructification" 

§ 93. ''Fructification" is the name given by Pro- 
fessor Bohm-Bawerk to the interest theories of Turgot 
and Henry George. 

Turgot's theory is expressed in these passages from his 
Reflections sur la Formation et la Distribution des Richesses 
(first printed in 1770) as translated by Professor W. J. 
Ashley.^ Some passages of special significance to us 
I have indicated by capitals. 

''Whoever, either from the revenue of his land, or 
from the wages of his labour or of his industry, receives 
each year more values than he needs to spend, may place 
this superfluity in reserve and accumulate it: these 
accumulated values are what is called a capital. The 
timid Miser, who amasses money only to quiet his im- 
agination against the apprehension of needing the neces- 
saries of life in an uncertain future, keeps his money 
in a hoard. If the dangers he foresaw should be reahzed 
and if he should be reduced by poverty to live each year 
upon his treasure, or if it should happen that a prodigal 
Heir should spend it by degrees, this treasure would soon 
be exhausted and the capital entirely lost to the Possessor: 
the latter can do much better with it. SINCE AN ES- 
TATE OF LAND OF A CERTAIN REVENUE IS 

iNew York, Macmillan, 1898. The three quotations are from 
pp. 50-51, 52-54, and 67-69 respectively. 



OTHER THEORIES OF INTEREST 179 

BUT THE EQUIVALENT OF A SUM OF VALUE 
EQUAL TO THIS REVENUE MULTIPLIED A 
CERTAIN NUMBER OF TIMES, IT FOLLOWS 
THAT ANY SUM WHATEVER OF VALUES IS THE 
EQUIVALENT OF AN ESTATE OF LAND PRO- 
DUCING A REVENUE EQUAL TO A DEFINITE 
FRACTION OF THAT SUM : it is absolutely indiffer- 
ent whether this sum of values or this capital consists 
in a mass of metal or anything else, since the money 
represents every kind of value, just as every kind of 
value represents money. The Possessor of a capital can 
then, in the first place, employ it in the purchase of 
lands ; but he has also other resources. 

''In the earliest times he who set men to work fur- 
nished the materials himself and paid from day to day 
the wages of the Workman. It was the Cultivator 
or the Proprietor himself that gave to the Spinner the 
hemp he had gathered, and maintained her during the 
time of her working ; then he handed over the yarn to 
a Weaver, to whom he gave every day the wages agreed 
upon ; but these slight daily advances could be sufficient 
only for works of the simplest and roughest kind. A 
great number of Crafts, and even of the Crafts engaged 
in by the poorest Members of the Society, require that 
the same material should pass through a crowd of differ- 
ent hands, and undergo for a very long time exceedingly 
difficult and various operations. I have already men- 
tioned the preparation of the leather whereof shoes are 
made : whoever has seen the establishment of a Tanner 
realizes the absolute impossibihty of one poor man, or 
even of several poor men, providing themselves with 



l8o A THEORY OF INTEREST 

hides, lime, tan, utensils, etc., getting the buildings 
erected which are necessary for setting a Tan-house in 
operation, and living during several months until the 
leather is sold. In this Craft, and in many others, must 
not those who work at it have learned the trade before 
they venture to touch the materials, which they would 
spoil in their first attempts ? Here, then, is another 
advance indispensable. Who, in the next place, will 
collect the materials for the work, the ingredients and 
the tools necessary for the process? Who will get 
canals, market halls, all the different kinds of buildings 
constructed? Who will enable that great number of 
Workmen to Hve until the leather is sold, of whom none 
could prepare a single skin by himself? Considering, 
moreover, that the profit on the sale of a single tanned 
hide could not furnish subsistence for any one of them. 
Who will defray the expenses for the instruction of Pupils 
and Apprentices ? Who will procure for them the means 
of subsistence until they are taught, by enabling them to 
pass step by step from labour which is easy and propor- 
tioned to their age to labours which demand the utmost 
vigour and abihty ? It will be one of those Possessors 
of capitals, or of movable accumulated values, who will 
employ them, partly in advances for the construction of 
the establishment and for the purchase of materials, 
partly for the daily wages of the Workmen who labour 
in the preparation (of the commodities). IT IS HE 
WHO WILL WAIT FOR THE SALE OF THE 
LEATHER TO RETURN TO HIM NOT ONLY 
ALL HIS ADVANCES BUT A PROFIT IN ADDI- 
TION, SUFFICIENT TO MAKE UP TO HIM FOR 



OTHER THEORIES OF INTEREST i8i 

WHAT HIS MONEY WOULD HAVE BEEN 
WORTH TO HIM IF HE HAD EMPLOYED IT 
IN THE PURCHASE OF AN ESTATE ; and, fur- 
thermore, for the wages due to his labours, his cares, his 
risks, and even his skill ; for doubtless, if the profit were 
the same, he would have preferred to five without exer- 
tion on the revenue of the land he could have acquired 
with the same capital. As fast as this capital comes 
back to him by the sale of the products, he uses it for 
new purchases in order to supply and maintain his Man- 
ufactory by this continual circulation : on his profits he 
lives, and he places on one side what he can spare to in- 
crease his capital and put into his business, adding to 
the amount of his advances in order to add still more to 
his profits. 

"The price of the loan is by no means founded, as might 
be imagined, on the profit the borrower hopes to make 
with the capital of which he purchases the use. This 
price is determined, like the price of all merchandise, 
by the chaffering of seller and buyer, by the balance of 
the offer with the demand. People borrow with every 
kind of purpose and with every sort of motive. This 
one borrows to undertake an enterprise which will make 
his fortune, this other to purchase an estate : another to 
pay a gaming debt ; another to make up for the loss of 
his revenue of which some accident has deprived him ; 
and another to keep himself alive until he can get some- 
thing by his labour ; but all these motives which in- 
fluence the borrower are quite indifferent to the lender. 
He cares about two things only, the interest he is to re- 
ceive, and the safety of his capital. He does not trouble 



1 82 A THEORY OF INTEREST 

himself about the use the borrower will make of it, any 
more than a Merchant concerns himself with the use a 
purchaser will make of the commodities he sells him. 

"It is for want of having looked at lending on interest 
in its true light that certain moralists, more rigid than 
enlightened, have endeavoured to make us regard it as 
a crime. The Scholastic theologians have concluded 
from the fact that money produces nothing by itself that 
it was unjust to demand interest for money placed on 
loan. Full of their prejudices, they have beHeved their 
doctrine was sanctioned by this passage of the Gospel : 
Mutuum date, nihil inde sperantes. Those theologians 
who have adopted more reasonable principles on the 
subject of interest have had to endure the harshest re- 
proaches from writers of the opposite party. 

"Nevertheless it needs but little reflection to realize 
the frivolity of the pretexts which have been made use 
of to condemn the taking of interest. A loan is a recipro- 
cal contract, free between the two parties, which they 
make only because it is advantageous to them. It is 
evident that, if the Lender finds it to his advantage to 
receive something as the hire of his money, the Borrower 
is equally interested in finding the money of which he 
stands in need ; as is shown by his making up his mind 
to borrow and to pay the hire of the money : but on 
what principle can one imagine a crime in a contract 
which is advantageous to the two parties, with which 
both are content and which certainly does not injure 
anyone else. To say that the Lender takes advantage of 
the Borrower's need of money to demand interest for 
it is to talk as absurdly as if one should say that a Baker 



OTHER THEORIES OF INTEREST 183 

who demands money for the bread he sells takes advan- 
tage of the Purchaser's need of bread. If, in the latter 
case, the money is the equivalent of the bread the Pur- 
chaser receives, the money which the Borrower receives 
to-day is equally the equivalent of the capital and of the 
interest which he promises to return at the expiration 
of a certain time ; for, in short, it is an advantage for the 
Borrower to have during this interval the money he 
stands in need of, and it is a disadvantage to the Lender 
to be deprived of it. This disadvantage is capable of 
being estimated, and it is estimated ; the interest is the 
price of it. This price ought to be higher if the Lender 
runs a risk of losing his capital by the insolvency of the 
Borrower. The bargain, therefore, is perfectly equal on 
both sides, and consequently fair. Money considered as 
a physical substance, as a mass of metal, does not pro- 
duce anything ; but money employed in advances for 
enterprises in Agriculture, Manufacture, and Com- 
merce procures a definite profit. WITH MONEY 
ONE CAN PURCHASE AN ESTATE, AND 
THEREBY PROCURE A REVENUE. THE PER- 
SON, THEREFORE, WHO LENDS HIS MONEY 
DOES NOT MERELY GIVE UP THE BARREN 
POSSESSION OF THAT MONEY; HE DEPRIVES 
HIMSELF OF THE PROFIT OR OF THE REV- 
ENUE WHICH HE WOULD HAVE BEEN ABLE 
TO PROCURE BY IT ; and the interest which in- 
demnifies him for this privation cannot be regarded as 
unjust." 

"The position of the Husbandman is very different 
[from that of landless workmen]. The land pays him 



184 A THEORY OF INTEREST 

directly the price of his labour, independently of any 
other man or any agreement. Nature does not bargain 
with him to obhge him to content himself with what is 
absolutely necessary. What she grants is proportioned 
neither to his wants, nor to a contractual valuation of the 
price of his days of labour. It is the physical result of 
the fertihty of the soil, and of the wisdom, far more than 
of the laboriousness, of the means which he has employed 
to render it fertile. As soon as the labour of the Hus- 
bandman produces more than his wants, he can, with 
this superfluity that nature accords him as a pure gift, 
over and above the wages of his toil, buy the labour of 
the other members of the society. The latter, in selhng 
to him, gain only their livelihood ; but the Husbandman 
gathers, beyond his subsistence, a wealth which is inde- 
pendent and disposable, which he has not bought and 
which he sells." 

''By this new arrangement [division of the land be- 
tween working farmers and non-working proprietors] 
the produce of the land is divided into two parts. The 
one includes the subsistence and the profits of the Hus- 
bandman, which are the reward of his labour and the con- 
dition upon which he undertakes to cultivate the field of 
the Proprietor. What remains is that independent and 
disposable part which the land gives as a pure gift to 
him who cultivates it, over and above his advances and 
the wages of his trouble ; and this is the portion of the 
Proprietor, or the revenue with which the latter can live 
without labour and which he carries where he will." 

From these passages it is clear that Turgot regards 
interest on loans as a mere reflection of the net revenue 



OTHER THEORIES OF INTEREST 185 

which an investment of the same amount in land might 
bring the investor, and that he regards the net revenue 
which the investment in land would yield as caused by 
the spontaneous fertility of the soil. 

This theory of interest is just as good as that which 
explains interest as due simply to the ''productivity" 
or usefulness of tools or machines — and no better. 
Both theories are plausible enough until the fatal question 
is asked, Why can the land, or the machine, be bought 
at a price lower than the sum of the prices of all its 
future services ? But when that question is asked, both 
theories fail utterly. 

§ 94. More than a hundred years after the publica- 
tion of Turgot's theory, a similar one was advanced by 
Henry George in his Progress and Poverty} The net 
revenue or surplus of which interest is a reflection is due, 
in George's thought, to "the active power of nature, the 
principle of growth, of reproduction, which everywhere 
characterizes all the forms of that mysterious thing or 
condition which we call life." The following passage 
from Progress and Poverty ^ expresses George's theory, 
which is clearly summed up in a few lines, near the end, 
which I have printed in capitals. 

"Why should interest be? Interest, we are told, in 
all the standard works, is the reward of abstinence. But, 
manifestly, this does not sufficiently account for it. 
Abstinence is not an active, but a passive quality ; it is 
not a doing — it is simply a not doing. Abstinence in 
itself produces nothing. Why, then, should any part of 

^Written in 1877-1879, published in 1879. 

2 Edition of Doubleday, Page and Co., N.Y., 1906, pp. 175-182. 



1 86 A THEORY OF INTEREST 

what is produced be claimed for it ? If I have a sum of 
money which I lock up for a year, I have exercised as 
much abstinence as though I had loaned it. Yet, though 
in the latter case I will expect it to be returned to me 
with an additional sum by way of interest, in the former 
I will have but the same sum, and no increase. But the 
abstinence is the same. If it be said that in lending it I 
do the borrower a service, it may be replied that he also 
does me a service in keeping it safely — a service that 
under some conditions may be very valuable, and for 
which I would willingly pay, rather than not have it ; and 
a service which, as to some forms of capital, may be even 
more obvious than as to money. For there are many 
forms of capital which will not keep, but must be con- 
stantly renewed ; and many which are onerous to main- 
tain if one has no immediate use for them. So, if the 
accumulator of capital helps the user of capital by loan- 
ing it to him, does not the user discharge the debt in full 
when he hands it back ? Is not the secure preservation, 
the maintenance, the re-creation of capital, a complete 
offset to the use ? Accumulation is the end and aim of 
abstinence. Abstinence can go no further and accom- 
plish no more ; nor of itself can it even do this. If we 
were merely to abstain from using it, how much wealth 
would disappear in a year ! And how little would be left 
at the end of two years ! Hence, if more is demanded 
for abstinence than the safe return of capital, is not 
labor wronged ? Such ideas as these underlie the wide- 
spread opinion that interest can accrue only at the ex- 
pense of labor, and is in fact a robbery of labor which in 
a social condition based on justice would be abolished. 



OTHER THEORIES OF INTEREST 187 

^'The attempts to refute these views do not appear to 
me always successful. For instance, as it illustrates the 
usual reasoning, take Bastiat's oft-quoted illustration of 
the plane. One carpenter, James, at the expense of ten 
days' labor, makes himself a plane, which will last in 
use for 290 of the 300 working days of the year. William, 
another carpenter, proposes to borrow the plane for a 
year, offering to give back at the end of that time, when 
the plane will be worn out, a new plane equally as good. 
James objects to lending the plane on these terms, 
urging that if he merely gets back a plane, he will have 
nothing to compensate him for the loss of the advantage 
which the use of the plane during the year would give 
him. William, admitting this, agrees not merely to 
return a plane, but, in addition, to give James a new 
plank. The agreement is carried out to mutual satis- 
faction. The plane is used up during the year, but at 
the end of the year James receives as good a one, and a 
plank in addition. He lends the new plane again and 
again, until finally it passes into the hands of his son, 
'who still continues to lend it,' receiving a plank each 
time. This plank, which represents interest, is said to 
be a natural and equitable remuneration, as by giving 
it in return for the use of the plane, William 'obtains 
the power which exists in the tool to increase the pro- 
ductiveness of labor,' and is no worse off than he would 
have been had he not borrowed the plane ; while James 
obtains no more than he would have had if he had re- 
tained and used the plane instead of lending it. 

"Is this really so ? It will be observed that it is not 
affirmed that James could make the plane and William 



1 88 A THEORY OF INTEREST 

could not, for that would be to make the plank the 
reward of superior skill. It is only that James had 
abstained from consuming the result of his labor until 
he had accumulated it in the form of a plane — which is 
the essential idea of capital. 

''Now, if James had not lent the plane, he could have 
used it for 290 days, when it would have been worn out, 
and he would have been obliged to take the remaining 
ten days of the working year to make a new plane. If 
William had not borrowed the plane, he would have 
taken ten days to make himself a plane, which he could 
have used for the remaining 290 days. Thus, if we take 
a plank to represent the fruits of a day's labor with the 
aid of a plane, at the end of the year, had no borrowing 
taken place, each would have stood with reference to 
the plane as he commenced, James with a plane, and 
William with none, and each would have had as the 
result of the year's work 290 planks. If the condition 
of the borrowing had been what William first proposed, 
the return of a new plane, the same relative situation 
would have been secured. William would have worked 
for 290 days, and taken the last ten days to make the 
new plane to return to James. James would have taken 
the first ten days of the year to make another plane 
which would have lasted for 290 days, when he would 
have received a new plane from William. Thus, the 
simple return of the plane would have put each in the 
same position at the end of the year as if no borrowing 
had taken place. James would have lost nothing to the 
gain of William, and William would have gained noth- 
ing to the loss of James. Each would have had the re- 



OTHER THEORIES OF INTEREST 189 

turn his labor would otherwise have yielded — viz., 290 
planks, and James would have had the advantage with 
which he started, a new plane. 

"But when, in addition to the return of a plane, a 
plank is given, James at the end of the year will be in a 
better position than if there had been no borrowing, and 
William in a worse. James will have 291 planks and a 
new plane, and William 289 planks and no plane. If 
William now borrows the plank as well as the plane on 
the same terms as before, he will at the end of the year 
have to return to James a plane, two planks and a frac- 
tion of a plank ; and if this difference be again borrowed, 
and so on, is it not evident that the income of the one 
will progressively decline, and that of the other will 
progressively increase, until at length, if the operation 
be continued, the time will come when, as the result of 
the original lending of a plane, James will obtain the 
whole result of William's labor — that is to say, William 
will become virtually his slave ? 

''Is interest, then, natural and equitable? There is 
nothing in this illustration to show it to be. Evidently 
what Bastiat (and many others) assigns as the basis of 
interest, 'the power which exists in the tool to increase 
the productiveness of labor,' is neither in justice nor in 
fact the basis of interest. The fallacy which makes 
Bastiat's illustration pass as conclusive with those who 
do not stop to analyze it, as we have done, is that with 
the loan of the plane they associate the transfer of the 
increased productive power which a plane gives to labor. 
But this is really not involved. The essential thing 
which James loaned to William was not the increased 



I go 



A THEORY OF INTEREST 



power which labor acquires from using planes. To sup- 
pose this, we should have to suppose that the making 
and using of planes was a trade secret or a patent right, 
when the illustration would become one of monopoly, 
not of capital. The essential thing which James loaned 
to William was not the privilege of applying his labor in 
a more effective way, but the use of the concrete result 
of ten days' labor. If 'the power which exists in tools 
to increase the productiveness of labor' were the cause 
of interest, then the rate of interest would increase with 
the march of invention. This is not so. Nor yet will 
I be expected to pay more interest if I borrow a fifty- 
dollar sewing machine than if I borrow fifty dollars' 
worth of needles ; if I borrow a steam engine than if I 
borrow a pile of bricks of equal value. Capital, like 
wealth, is interchangeable. It is not one thing; it is 
anything to that value within the circle of exchange. 
Nor yet does the improvement of tools add to the re- 
productive power of capital ; it adds to the productive 
power of labor. 

''And I am incHned to think that if all wealth con- 
sisted of such things as planes, and all production was 
such as that of carpenters — that is to say, if wealth 
consisted but of the inert matter of the universe, and 
production of working up this inert matter into different 
shapes, that interest would be but the robbery of in- 
dustry, and could not long exist. This is not to say 
that there would be no accumulation, for though the 
hope of increase is a motive for turning wealth into 
capital, it is not the motive, or, at least, not the main 
motive, for accumulating. Children will save their 



OTHER THEORIES OF INTEREST 



191 



pennies for Christmas; pirates will add to their buried 
treasure; Eastern princes will accumulate hoards of 
coin ; and men like Stewart or Vanderbilt, having become 
once possessed of the passion of accumulating, would 
continue as long as they could to add to their millions, 
even though accumulation brought no increase. Nor 
yet is it to say that there would be no borrowing or lend- 
ing, for this, to a large extent, would be prompted by 
mutual convenience. If William had a job of work to 
be immediately begun and James one that would not 
commence until ten days thereafter, there might be a 
mutual advantage in the loan of the plane, though no 
plank should be given. 

''But all wealth is not of the nature of planes, or 
planks, or money, which has no reproductive power ; 
nor is all production merely the turning into other forms 
of this inert matter of the universe. It is true that if 
I put away money, it will not increase. But suppose, 
instead, I put away wine. At the end of a year I will 
have an increased value, for the wine will have improved 
in quality. Or supposing that in a country adapted to 
them, I set out bees ; at the end of a year I will have more 
swarms of bees, and the honey which they have made. 
Or, supposing, where there is a range, I turn out sheep, 
or hogs, or cattle ; at the end of the year I will, upon 
the average, also have an increase. 

''Now what gives the increase in these cases is some- 
thing which, though it generally requires labor to utiHze 
it, is yet distinct and separable from labor — the active 
power of nature ; THE PRINCIPLE OF GROWTH, 
OF REPRODUCTION, WHICH EVERYWHERE 



192 A THEORY OF INTEREST 

CHARACTERIZES ALL THE FORMS OF THAT 
MYSTERIOUS THING OR CONDITION WHICH 
WE CALL LIFE. AND IT SEEMS TO ME THAT 
IT IS THIS WHICH IS THE CAUSE OF INTEREST, 
OR THE INCREASE OF CAPITAL OVER AND 
ABOVE THAT DUE TO LABOR. There are, so to 
speak, in the movements which make up the everlasting 
flux of nature, certain vital currents, which will, if we 
use them, aid us, with a force independent of our own 
efforts, in turning matter into the forms we desire — 
that is to say, into wealth. 

*' While many things might be mentioned which, like 
money, or planes, or planks, or engines, or clothing, have 
no innate power of increase, yet other things are in- 
cluded in the terms wealth and capital which, like wine, 
will of themselves increase in quality up to a certain 
point ; or, like bees or cattle, will of themselves increase 
in quantity; and certain other things, such as seeds, 
which, though the conditions which enable them to in- 
crease may not be maintained without labor, yet will, 
when these conditions are maintained, yield an increase, 
or give a return over and above that which is to be 
attributed to labor. 

''Now the interchangeability of wealth necessarily 
involves an average between all the species of wealth of 
any special advantage which accrues from the posses- 
sion of any particular species, for no one would keep 
capital in one form when it could be changed into a 
more advantageous form. No one, for instance, would 
grind wheat into flour and keep it on hand for the con- 
venience of those who desire from time to time to ex- 



OTHER THEORIES OF INTEREST 193 

change wheat or its equivalent for flour, unless he could 
by such exchange secure an increase equal to that which, 
all things considered, he could secure by planting his 
wheat. No one, if he could keep them, would exchange 
a flock of sheep now for their net weight in mutton to 
be returned next year ; for by keeping the sheep he would 
not only have the same amount of mutton next year, 
but also the lambs and the fleeces. No one would dig 
an irrigating ditch, unless those who by its aid are en- 
abled to utilize the reproductive forces of nature would 
give him such a portion of the increase they receive as to 
make his capital yield him as much as theirs. And so, 
in any circle of exchange, the power of increase which 
the reproductive or vital force of nature gives to some 
species of capital must average with all; and he who 
lends, or uses in exchange, money, or planes, or bricks, 
or clothing, is not deprived of the power to obtain an 
increase, any more than if he had lent or put to a repro- 
ductive use so much capital in a form capable of in- 
crease." 

Between this theory and Turgot's the differences are 
only superficial. The part played by the natural fer- 
tility of the soil in Turgot's theory is taken in George's 
by the vital and reproductive forces of plants and ani- 
mals. And both these theories differ only superficially 
from the productivity theory in its simplest and crudest 
form, according to which interest is accounted for by 
the utility of tools and labor-saving devices. 

The ''fructification theory," in the form it takes with 
George as well as in that it takes with Turgot, is revealed 
as utterly inadequate by the single question that reveals 



194 A THEORY OF INTEREST 

also the inadequacy of the productivity theory : Why 
can a cow, why can a young apple tree, why can a plow or a 
steam engine he bought at a price lower than the sum of the 
prices oj all its future services ? If a cow or an apple 
tree or a plow could not be bought at such a price, no 
interest would accrue to its owner as its services came 
in with the passing of time ; and that a cow or an apple 
tree or a plow can be bought thus is not accounted for 
in the least by the vital forces in animals or plants, by 
the fertility of the soil, or by the usefulness of tools. 
The only productivity in connection with animals or 
plants, or with the soil, or with tools, that is significant 
in connection with the interest problem is value-produc- 
tivity, and the value-productivity of anything whatever 
is accounted for only by the discounting of future ser- 
vices by particular persons or groups of persons in order 
that the future services received, principal and interest 
together, shall equal in value to those persons or groups 
of persons the present services advanced. 

The '' Sacrifice Capitalistique " 

§ 95. In his V Inter et du Capital,^ M. Adolphe Landry 
explains, under the name of the ''sacrifice capitalistique," 
a principle not previously suggested, so far as I know, 
by any economist, which he regards as accounting in part 
for the checking of advancing at such a point as to 
maintain a positive rate of interest. This principle is of 
special interest to me because I had hit upon it myself 
independently a few months before reading Landry's 

1 Paris, V. Giard & E. Briere, 1904. 



OTHER THEORIES OF INTEREST 195 

book, and regarded it, at that time and for a while after 
I read Landry, as one of the important keys to the solu- 
tion of the interest problem. The principle is explained 
by Landry briefly ^ as '7e fait que tout deplacement dans 
la consommation est prejudiciable, en tant quHl rompt 
Vequilihre de la consommation, quHl aggrave un defaut 
d'equilibre, ou quHl remplace un defaut d'equilihre par un 
defaut d'equilihre inverse et plus marque.^'' 

It is explained more fully as follows, on pp. 53-56 
of the work cited. A translation follows. 

"Nous arrivons maintenant a un cas nouveau, dont 
rimportance pratique est tres grande : le cas ou les 
besoins comme les ressources demeurent les memes a 
travers le temps. Dans ce cas encore la capitalisation 
ne pourra avoir lieu que si elle doit donner un rendement. 

"^Je suppose que mes ressources soient de 15,000 
francs pour cette annee et de 15,000 francs encore pour 
Tannee prochaine, et que pour une consommation de 
15,000 francs les derniers 100 francs depenses doivent 
me procurer, cette annee-ci, comme I'annee prochaine, 
une utilite que j'estime a M. II s'agit pour moi d'avancer 
1000 francs pendant un an? Je me verrais contraint 
de reduire mon bien-etre, cette annee-ci, de 
M -h M' -f M'' -f . . . , et je me mettrais a 
meme d'accroitre mon bien-etre. Tan prochain, de 
Ml + M2 + M3 -{-.... Or la loi de la decroissance 
de I'utilite qui veut que I'utilite d'une certaine quantite 
d'un bien soit d'autant plus faible qu'on possede deja 
une plus grande quantite du bien en question, cette loi, 
par cela meme qu^elle s^applique a tous les autres biens, 

1 Work cited, p. 145. 



196 A THEORY OF INTEREST 

s'appKque a ce bien d'une nature tres particuKere qu'est 
Fargent. Employant au mieux notre argent, nous nous 
procurons avec des sommes successives egales des satis- 
factions tou jours plus faibles. On a done 

. . . M'' > M'>M > Ml > M2 > Ms . . . , 

et par suite 

M + M' + M'' + . . . > Ml + M2 + M3 + . . . 

L'avance dont je parlais ne deviendra possible que si 
elle doit donner un rendement au moins egal a la dif- 
ference 

(M -f M' -f- M'' + . . .) - (Ml + M2 + M3 + . . .)• 

*'S'il s'agissait d'avancer 2000 francs au lieu de 1000 
francs, le rendement exige serait plus que double ; car a 
la serie M + M' + M'^ + . . . viendraient s'ajouter 
dix termes tous plus grands que les dix premiers, et a 
la serie Mi -f M2 + M3 + . . . viendraient s'ajouter 
de meme dix termes plus petits que les dix premiers. 
La somme a capitaliser augmentant, le rendement exige 
subirait une augmentation, non pas proportionnelle, 
mais plus rapide. Ainsi la decroissance de I'utilite agit 
comme une sorte de frein qui arrete la capitalisation, et 
elle agit d'une maniere tou jours plus puissante pour une 
capitalisation plus forte. 

"On voit le lien etroit qui rattache ensemble toutes 
les considerations qui viennent d'etre developpees. 
Toutes decoulent d'un meme principe, a savoir que la 
meilleure fagon de distribuer sa consommation dans le 
temps est celle qui fait que les derniers besoins satisfaits 
ont la meme importance a chaque moment du temps. 



OTHER THEORIES OF INTEREST 197 

De ce principe, que j'appellerai le principe de I'equilibre 
de la consommation, les consequences suivantes se 
deduisent : 

"1°. la capitalisation necouterien au capi talis te quand 
elle tend a etablir I'equilibre de la consommation ; 

' ' 2° . la capitalisation coute au capitaliste — et celui-ci, 
par suite, ne s'y decidera que moyennant I'assurance de 
percevoir un surplus — lorsqu'elle detruit I'equilibre de 
la consommation, ou qu'elle aggrave le defaut d'equilibre 
de cette consommation. 

''Or, la capitalisation tend a etabKr I'equilibre de la 
consommation : 

'' (a) quand les besoins doivent croitre ; 

'' (b) quand les ressources doivent diminuer. 

"La capitalisation, d'autre part, detruit I'equilibre de la 
consommation, ou aggrave le defaut d'equiKbre : 

" (a) quand les besoins doivent diminuer ; 

'' (b) quand les ressources doivent croitre ; 

" (c) quand les besoins et les ressources doivent rester 
les memes. 

"Si nous nous attachons uniquement aux facteurs qui 
s'opposent a la capitalisation, nous pourrons dire que ces 
facteurs se reduisent a un, puisque c'est toujours la loi 
de la decroissance de I'utilite qui, dans les cas enumeres 
ci-dessus, fait la 'rarete du capital,' empeche que les 
capitaux soient avances a moins de I'assurance d'une 
plus- value. En un certain sens, cependant, nous sommes 
en droit de dire que nous avons trois causes : tantot, en 
effet, c'est parce qu'une diminution des besoins empeche 
I'equilibre de la consommation que la capitalisation, 
aggravant ce defaut d'equilibre, est en elle-meme fa- 



IC)8 A THEORY OF INTEREST 

cheuse ; tantot c'est parce qu'il y a accroissement des 
ressources que la capitalisation est encore facheuse, et 
de la meme maniere ; tantot enfin, au lieu d'aggraver, 
la capitalisation cree le defaut d'equilibre de la consom- 
mation. Pour la commodite de I'exposition, je dirai 
desormais, parlant de ces trois causes : la diminution 
des besoins, I'accroissement des ressources et le sacrifice 
capi talis ti que." 

Translation of the passage quoted from pp. 53-56 of 
Landry's Ulnteret du Capital: — 

*'We come now to a new case, the practical impor- 
tance of which is very great, the case in which wants as 
well as resources remain the same throughout the time. 
In this case also capitalization ^ can take place only if 
it is to yield a surplus.^ 

''Suppose that my resources are 15,000 francs for 
this year and 15,000 francs for next year also, and 
that in the case of a consumption of 15,000 francs 
the last 100 francs spent are to yield me, this year or 
next indifferently, a utility that I estimate as M. The 
question is whether I shall advance 1000 francs for a 
year. I should have to reduce my well-being [if 
I did advance the 1000 francs], this year, from 
M -f M' + M'^ -}-..., and I should be in a posi- 
tion to increase my well-being, next year, from 
M1+M2+M3+ . . . Now the law of diminishing 
utihty, according to which the more one has of a good, 
the less is the value of a given quantity of it, — this 
law, precisely because it is applicable to all other goods, 
is apphcable to that good, of quite special character, 

1 In the sense of advancing. ^ Rendement. 



OTHER THEORIES OF INTEREST 



199 



which is called money. Using our money to the best 
advantage, we shall secure for ourselves, with successive 
equal sums, less and less returns of satisfaction. We 
have, then, 

]Vr' > M' > M > Ml > M2 > M3 . . . 

and hence 

M + M' + M'' + . . . > Ml + M2 + M3 + . . . 

The advance of which I spoke will become possible 
only if it is to yield a surplus ^ at least equal to the 
difference 

(M + M' + M^^ + . . .) - (Ml + M2 + M3 + . . .). 

"If it were a question of advancing 2000 francs 
instead of 1000 francs, the surplus ^ exacted would 
have to be more than doubled ; for to the series 
M + M' + M'' + . . . there would have to be added 
ten terms all greater than the first ten, and to the series 
Ml + M2 + Ms + . . . there would have to be added 
ten terms all smaller than the first ten. As the sum to 
be capitahzed ^ increased, the surplus exacted would 
have to increase not proportionally but acceleratively. 
Thus diminishing utihty acts as a sort of check to capi- 
talizing ^ ; and the greater the capitalization, the more 
powerful its action. 

"It is clear how closely bound together are the con- 
siderations that have just been developed. All follow 
from one principle, namely that the best way to dis- 

1 Rendement. ' In the sense of advanced. 

2 Rendement. ■* In the sense of advancing. 



200 A THEORY OF INTEREST 

tribute one's consumption through time is that which 
makes the last wants satisfied at each moment of the 
time have the same importance. From this principle, 
which I shall call the principle of the equilibrium of the 
consumption^ the following conclusions may be deduced : 

'' I St. capitalizing [advancing] costs the capitalist [cap- 
italizer or advancer] nothing when it tends to establish 
equilibrium of the consumption; 

''2nd. capitalizing [advancing] costs the capitalist [capi- 
talizer or advancer] something — and therefore he will 
decide upon it only in case he is sure of receiving a sur- 
plus thereby — when it destroys the equilibrium of the 
consumption, or when it aggravates a defect of the equi- 
librium of this consumption. 

''But capitalizing [advancing] tends to establish the 
equilibrium of the consumption ^ : 

" (a) when wants are to increase ; 

" {b) when resources are to decrease. 

"Capitalizing [advancing], on the other hand, destroys 
the equiHbrium of the consumption,^ or aggravates a 
defect of equilibrium : 

" (a) when wants are to decrease ; 

" ib) when resources are to increase ; 

" (c) when wants and resources are to remain the same. 

" If we regard only the factors that check capitahzing 
[advancing], we can say that these factors may be re- 
duced to one, since it is always the law of diminishing 
utiHty which, in the cases enumerated above, causes 
the 'scarcity of capital,' prevents the advancement of 

^ The word in the text is "capitalisation," evidently a misprint for 
' ' consommation. ' ' 



OTHER THEORIES OF INTEREST 201 

capital except with the assurance of a surplus. In a 
certain sense, however, we are right in saying that we 
have three causes : sometimes, indeed, it is because a de- 
crease of wants upsets the equilibrium of the consump- 
tion that capitaHzing [in the sense of making advances], 
aggravating this defect of the equilibrium, is in itself 
disadvantageous ; sometimes it is because there is an in- 
crease of resources that capitalizing is disadvantageous, 
and in the same way ; sometimes, finally, capitalizing, 
instead of aggravating, creates the defect of the equilibrium 
of the consumption. For convenience I shall say hence- 
forth, in speaking of these three causes, the decrease of 
wants, the increase of resources, and the sacrifice of capi- 
talizing [le sacrifice capitalistique].^' 

§ 96. The principle which Landry thus explains 
under the name of the ^'sacrifice capitalistique " may 
well be explained again briefly in different words. Sup- 
pose a man whose wants are to remain the same next 
year as this year earns $500 this year and expects to 
earn the same next year. The question arises whether 
he shall invest |io for one year. If he does so, he will 
have for consumption this year, aside from any interest 
that he may receive on the investment, $490 ; and for 
consumption next year, aside from interest, $510. This 
means that, aside from any benefit he may receive from 
interest, he is injured by the transaction to just the extent 
that the wants satisfied by the last $10 of $510 are less 
urgent than those that would have been satisfied by the 
last $10 of $500. The transaction involves his shifting 
the expenditure for consumption of $10 from a time when 
he has already spent only $490 in the year to a time when 



202 A THEORY OF INTEREST 

he has already spent $500 in the year, and when, there- 
fore, so far as the shifting is concerned, the next $10 is 
less urgently needed. To undertake the transaction, 
therefore, involves a sacrifice, the "sacrifice of capitaliz- 
ing," the sacrifice caused by the very capitalizing itself, 
the ''sacrifice capi talis ti que." Consequently, says Lan- 
dry, a man will not normally undertake the transaction 
unless he is assured of a surplus for doing it, which sur- 
plus is interest or at least an element of interest. This 
principle, Landry believes, is constantly at work, no 
matter what the relations of want and provision at the 
two times in question ; and its resultant effect is bound 
to be to help maintain a positive rate of interest. 

§ 97. Now, plausible as this reasoning may seem at 
first, it is, if I am not mistaken, fallacious. It is quite 
true that the shifting of consumption involved in capi- 
talizing may often require the sacrifice Landry points 
out. It may be admitted, indeed, for the sake of argu- 
ment, that that shifting of consumption involves the 
sacrifice pointed out more often than not. But that by 
no means proves that this "sacrifice of capitalizing" is 
a cause of the persistence of a positive rate of interest. 
Why? Because a corresponding sacrifice is required, 
according to the very principle pointed out by Landry, 
by the shifting of consumption involved in decapitalizing 
what has once been capitalized. In other words, though 
capitalizing may often cost the capitalizer something, 
unless he gets a surplus through it, by distributing his 
consumable income unfavorably in time, yet decapitaliz- 
ing costs the capitalizer something just as often, for the 
same reason ; so that the resultant effect of the principle 



OTHER THEORIES OF INTEREST 



203 



would seem to be, not to reduce the total amount of 
advances to nature, but only to check capitalizing and 
decapitalizing equally. Just as it is a disadvantage, as 
Landry points out, for a man, for example, whose income 
and whose needs are constant to give up the consumption 
of $10 when he has spent but $490 in the year in order 
to have the consumption of the same $10 when he has 
spent $500 during the year, so it is a disadvantage also 
for the same man, after having once capitalized the $10, 
to give up the consumption of $.30 per year for 33I 
years — in each of which years the $ .30 is in addition 
to a constant income of, say, $500 — in order to consume 
$510 the year he decapitalizes and only $500 for each of 
the 32I years thereafter.^ 

It seems to me that the principle pointed out by 
Landry has as much effect in keeping invested in ad- 
vances to nature what is once invested there as it has 
in preventing them to begin with. And if that is true, 
the principle is not a cause of the persistence of interest. 

The Monopoly Theory 

§ 98. Some writers of the philosophical anarchist 
school, including Proudhon in France and Benjamin R. 
Tucker in the United States, have held a theory of 
interest which is fairly summed up, I think, in the fol- 
lowing interpretation of it by a Philadelphian engaged 
in the banking business. 

^ Here I am considering only the principle pointed out by Lan-dry. 
For other reasons, of course, which I have explained at length in the 
previous chapters, it may be of advantage to a man to exchange $ .30 
a year for 335 years for $10 at present. 



204 A THEORY OF INTEREST 

§ 99. "The scientific thinkers of this school hold 
that, for all freely reproducible goods, value (and its 
equivalent price when the thing or good is expressed in 
terms of the adopted value unit) is, in a normal market, 
with absolute free competition, determined by both final 
utihty and marginal cost. The term 'freely repro- 
ducible ' embraces all that important and large class of 
staple goods and necessaries of life in which flexibility 
in supply exists, which are the rule and not the excep- 
tion in a free market. While utility must be accepted 
as the principle which creates the desire and originates 
value, cost of production at the margin is 'what governs 
the quantity supplied and with it the value of things.' 
In the case of 'scarcity' goods (which are the excep- 
tion and not the rule in a free market) such as old wine, 
oil paintings, etc., in which supply is fixed, value is 
determined by final utility. For the vast quantity and 
most important classes of goods, then, market price 
will, with free competition, tend always to settle at the 
cost of production at the margin. Supply will be 
adapted to demand. 

"Although in the abstract and popular sense both are 
included in the term 'capital,' for clearness in exposi- 
tion a distinction is made between capital-goods and 
money. We have consequently to treat separately of 
the profit on capital-goods and the interest on money, 
and to determine what it is that causes these persistent 
incomes, which are payments for impersonal services, to 
arise. 

"Capital-goods are not only tools, machinery, build- 
ings, and other aids to production, but also goods in 



OTHER THEORIES OF INTEREST 205 

course of production; in short, they are the results of 
past labor utilized through present or future labor to 
produce consumable commodities ; whereas money, 
'which can never be used in the act of production, can- 
not be capital when that term is used in its concrete 
sense.' 

''By money we mean that 'product of social com- 
pact,' or medium of exchange, which has been adopted 
by common consent as generally acceptable in over- 
coming the difficulties of simple barter. The mediating 
of exchanges is its chief function. Anything is money 
which fulfills those conditions. Gold as money has long 
since proved utterly inadequate to meet the growing 
demand for the medium of exchange necessary for the 
complex and tremendous scale on which modern indus- 
try is carried on, and credit money has been introduced, 
until today for every dollar of gold there is in circula- 
tion about eight dollars of credit money. This credit 
money consists of treasury notes, bank notes, bank 
credits circulating through checks, etc. 

"Money is an absolutely indispensable factor in 
modern production and exchange. Without it a return 
to simple barter would be imperative, and our advanced 
form of civilization impossible. Consequently if the 
supply of money is insufiicient, the competition for it 
will result in a premium, or interest, paid by borrowers 
for its use. 

"The inadequate supply of money is due to restric- 
tions imposed by law on the issue of money, which pre- 
vents the natural adaptation of supply to demand. 
This is true of all present kinds of money except gold. 



2o6 A THEORY OF INTEREST 

the supply of which is restricted by nature. Among 
the several legal restrictions is the national tax of ten 
per cent on state bank issues. 

''The recompense or interest on money loans is 'de- 
termined in the market by the same process which deter- 
mines the value of other services.' By the limitation 
of supply, money is made, as it were, similar to 'scarcity' 
goods, the price of which is determined by the utiHty to 
the user, or by final utility. Thus a difference, called 
interest, constantly exists between the cost of issuing 
money (that is, of mint-stamping the gold, or preparing 
the credit notes, etc.) and the price which money com- 
mands in the market. We do not here refer to the cost, 
or the value, of the commodity gold, or the other com- 
modities which secure the credit notes. If the supply 
were free from all restrictions (save those necessary for 
redemption and validity), supply would naturally tend 
to adapt itself to demand, as in the case of freely repro- 
ducible goods, the price of which is determined by cost 
of production at the margin. 

"There is no valid reason why a greater extension of 
credit money could not readily and safely be introduced, 
secured, both primarily and secondarily, by deposit of 
wealth to insure redemption in the unit of value, which 
at present is gold. The value of this credit money, 
redemption assured, would correspond to the value of 
the gold and could not possibly fall below it, even were 
the volume largely increased. As the cost of issuing 
credit money will, under free competition, adjust itself 
to the labor of preparing the tokens and handling the 
loans, in other words as price will conform to cost, it 



OTHER THEORIES OF INTEREST 207 

follows that the portion of pure interest now exacted 
for money loans by reason of the scarcity of money will 
be eliminated. 

''At present only certain specified and limited kinds 
of wealth can legally be monetized, and the result is an 
inadequate supply of money and the rise of interest. 
To the holders of this privileged wealth the holders of 
all other kinds of wealth are obliged to pay tribute 
before they can enter the competitive market. The 
payment of interest is a tax levied by monopoly. 

''As it is today, a bank is enabled by reason of the 
inadequate supply of money to collect pure interest 
(that is, that part of gross interest in excess of charges 
for labor and insurance) for a service which consists 
merely in exchanging its known and widely available 
credit notes, that have been endowed with the monetary 
privilege, for the equally good but unknown and un- 
available credit notes of its customers which are not so 
endowed. In all business loans the customer, by pledge, 
either directly or indirectly, of wealth or capital, secures 
the bank, so that it is not capital which he borrows and 
for which he pays interest; nor is it capital which the 
bank lends and for which it obtains interest. The trans- 
action is merely an exchange of one form of credit for 
another, the only difference being that the customer's 
credit, though equal in value to the bank's credit, ' is 
by law disquahfied from being used as a medium of 
exchange.' 

"In the case of unsecured loans payment is for risk, 
which is not interest but insurance ; but where there is 
no risk there can, under free competition, be no exaction 



208 A THEORY OF INTEREST 

of payment. There can be no benefit conferred where 
there is no burden borne. 

"Capital goods, the agencies of production, are what 
men really want to get. But as money is essential for 
the transfer of these, the ability to obtain money at 
cost secured by their own property enables them to buy 
capital goods and thus avoid the necessity of borrowing 
them. 

''Mr. B. R. Tucker, in one of his articles, propounds 
the following problem : — 

'"A is a farmer owning a farm. He mortgages his farm to a 
bank for $1000, giving the bank a mortgage note for that sum and 
receiving in exchange the bank's notes for the same sum, which 
are secured by the mortgage. With the bank notes A buys farm- 
ing tools of B. The next day B uses the notes to buy of C the 
materials used in the manufacture of tools. The day after C in 
turn pays them to D in exchange for something that he needs. At 
the end of the year, after a constant succession of exchanges, the 
notes are in the hands of Z, a dealer in farm produce. He pays 
them to A, who gives in return $1000 worth of farm products 
which he has raised during the year. Then A carries the notes 
to the bank, receives in exchange for them his mortgage note, and 
the bank cancels the mortgage. Now, in this whole circle of trans- 
actions has there been any lending of capital ? If so, who was the 
lender ? If not, who is entitled to any interest ? ' 

§ 100. ''Having determined the cause of interest on 
money loans, and how such interest may be eliminated, 
we now turn to the question of profits on capital goods. 

"The question is (to use the words of another to 
whom the present writer is indebted for some views ex- 
pressed herein, but whose name is purposely omitted) : 
'Why is it that the product obtained with the use of 



OTHER THEORIES OF INTEREST 209 

capital exceeds the cost of production and thus affords 
an income for capital, or, in short, why does capital get a 
profit?' 

"As has been stated, the value, or price, of freely re- 
producible goods is, in a free market, regulated by the 
cost of production at the margin. This necessarily 
results in the intra-marginal producer, whose cost is 
lower, reaping a profit. We are forced to the conclusion 
that this profit is due to an advantage which the intra- 
marginal producer possesses over the marginal producer. 
This advantage is due in turn to the interest which the 
marginal producer pays on money loans. The marginal 
producer, so far as money is concerned, is obhged to 
borrow money with which to obtain the capital-goods 
employed in production. The intra-marginal producer 
does not need to borrow. The producer, therefore, who 
is free from debt, or the intra-marginal producer, reaps 
a profit over the producer who is obliged to borrow, or 
the marginal producer, corresponding to the interest 
which the latter must pay on money loans equal to the 
capital which he employs. The rate of interest on 
money loans thus tends to govern the rate of capital- 
profit, is indeed the cause and not the effect of capital- 
profit. As Mr. Tucker says, 'The rate of interest on 
money fixes the rate of interest on all other capital the 
production of which is subject to competition, and when 
the former disappears the latter disappears with it.' 

"Interest on money loans is paid by producers because 
of the special advantages which money affords as a 
medium of exchange. We have already noted, however, 
that money commands interest because of an inade- 



2IO A THEORY OF INTEREST 

quate supply, due to legal restrictions which keep the 
supply from adapting itself to the demand. Now, with 
these restrictions removed, all producers with property 
or credit will be able to obtain money without payment 
of interest, and all, therefore, will be equally at the 
margin so far as money is concerned. It follows that 
under free competition no persistent profit is possible. 
What may be called 'chance' profits may arise, but 
they are transitory and are, in the average, offset by 
'chance' losses. The price of freely reproducible goods 
will tend to settle at the cost of production at the margin. 
Interest on money loans, being eliminated, can no longer 
be included as an element of cost in production, and 
thus cost at the margin will be merely a labor cost. 
Competition being free, final utility and marginal labor 
cost will become equal quantities. When interest 
vanishes, the entire product will be wages (omitting the 
question of rent). 

"Capital is an aid to labor, and the self-interest of 
every producer induces the adoption of the capitaHstic 
or indirect method of production because it yields a 
larger product. This is a great incentive for the saving 
and investing of capital. But with interest charges on 
money it is unprofitable to use more than a limited 
amount of capital, and consequently labor is only par- 
tially benefited and employed. Labor does not reach 
its maximum efficiency and the supply of capital is 
thereby limited. It is manifest that by an increase of 
capital labor's productivity will be enhanced and the 
net return to capital diminished. With interest on 
money eliminated, capital will be in more abundant 



OTHER THEORIES OF INTEREST 211 

and cheaper supply, and, as a result, more capital will 
be profitably used, until all labor is employed at its 
maximum efficiency and the supply of capital in con- 
sequence is still further increased. This process will 
continue until gradually, under the force of free com- 
petition, the final efficiency of capital and the power of 
capital to return a net income reach the vanishing point. 

" ' If I were free,' says Mr. Tucker, ' to use my capital directly 
as a basis of credit or currency, the relief from the necessity of 
borrowing additional capital from others would decrease the bor- 
rowing demand, and therefore the rate of interest. And if, as 
the Anarchists claim, this freedom to use capital as a basis of 
credit should give an immense impetus to business and conse- 
quently cause an immense demand for labor and consequently 
increase productive power, and consequently augment the amount 
of capital, here another force would be exercised to lower the rate 
of interest and cause it to gradually vanish.' 

*' Capital is scarce and in inadequate supply because 
the processes of production and exchange are hampered 
by an arbitrary limitation of the medium of exchange. 
Free competition is interfered with and, as a conse- 
quence, supply is not adapted to demand. The prices 
of freely reproducible goods rule above labor cost of 
production at the margin, yielding to capital a persist- 
ent net return or interest. There is nothing to prevent 
this interest from falling to zero, provided the produc- 
tion and accumulation of capital are not discouraged. 

"The conclusion is that interest arises not from 
economic exigencies, but from the monopoly of money 
created by arbitrary restrictions on the supply of money 
imposed by the state." 



212 A THEORY OF INTEREST 

§ loi. This theory makes all interest dependent on 
loan interest, and accounts for loan interest by the 
scarcity of the supply of credit currency, owing to gov- 
ernmental restrictions. 

Now, as I have shown throughout this book, natural 
interest is independent both of loan interest and of 
currency. In accounting, indeed, for natural interest, 
which I define as the price of advances to nature, I did 
not have occasion even to mention currency at all. 
Yet, strong as this is as evidence of the fallacy of the 
anarchists' reasoning, I will not rely on it only : I will 
try to point out some of the fallacies specifically. 

§ I02. In his fifth paragraph my "extreme Hber- 
tarian" opponent writes that "if the supply of money 
is insufficient, the competition for it will result in a 
premium, or interest, paid by borrowers for its use." 
Let us analyze this. "Money" may mean the standard 
of value, or the legal tender, or the medium of exchange, 
or any combination of these. 

Now, whatever restricts or keeps down the supply of 
the standard of value makes each unit of that standard 
of value more valuable relatively to all other things. 
But what effect does that have on interest ? If a dollar 
is very hard to come by, say as hard to come by as three 
bushels of potatoes, then of course it means three times 
as much to return a loan of a dollar as it would if a 
dollar were no harder to come by than one bushel of 
potatoes. But exactly the same is true of lending a 
dollar. Whether the supply of the dollar as standard 
of value is much restricted, either by nature or by law, 
therefore, has no more to do with the rate of interest 



OTHER THEORIES OF INTEREST 213 

than has the difference between a larger loan and a 
smaller one. 

What if by ''money " we mean ''legal tender " ? Well, 
it is possible that a premium may be paid for the tem- 
porary use of what the law requires for the fulfilment of 
a contract made in terms of money. It is therefore 
true that the need of money to carry out contracts in 
accordance with the requirements of the law may oc- 
casionally add to the interest proper, which I have tried 
to account for in this book, an extra premium which in 
business circles is naturally called by the same name, 
"interest." But interest proper would persist, for the 
reasons I have pointed out, even if this occasional extra 
premium were done away with by enlightened legisla- 
tion. 

What if by money we mean the mere medium of ex- 
change ? What, in that case, is the effect of restricting 
the supply of money? Undoubtedly it is to increase 
the cost of production generally, for the medium of ex- 
change is one of the most important of the labor-saving 
instruments of production. But that has no direct 
effect on the rate of interest. This is a puzzling point, 
requiring the most careful analysis. It is true, of 
course, that anything which increases the cost of pro- 
duction generally must on that account decrease the 
amount, as measured objectively, of the services men 
will advance to nature. And at first thought it must 
seem almost certain, according to my own theory as 
expressed in §§ 62 and 66, that whatever decreases the 
objective amount of the services advanced to nature 
must raise the rate of interest. But in that reasoning 



214 A THEORY OF INTEREST 

there is a subtle error. Consider the meaning of Dia- 
gram IV (§ 6i) once more. There the distance LV 
measured, not an amount of objective services embodied in 
advances (to nature), but an amount of advances (to 
nature). Advances (of any kind), however, are things 
of three dimensions or factors, as explained in §§ 30 and 
31 ; it is only what decreases the product of two of those 
factors — the two whose product is the nominal value of 
the services that constitute the principal of the advance 
— that raises the rate of interest ; and that product is 
not necessarily decreased by an increase of the general 
cost of production. 

§ 103. I can now point out what seems to me the 
underlying error of the anarchist theory of the cause 
of the persistence of interest. The anarchist theory 
confuses the price of money with the price of an advance 
of money or goods or services. It is of an advance of 
money — or of other goods or services — that interest 
is the price. The anarchist argument quoted above 
does not concern itself at all, it will be noticed, with the 
price of advances : it concerns itself only with the price 
of money itself. The same criticism may be made of 
any other anarchist argument on interest that I know. 

§ 104. Before passing from this anarchist theory of 
interest I should give due attention to Tucker's clever 
problem in the thirteenth paragraph of the banker's 
explanation. Whether that problem has ever been 
solved or not I do not know. But it is a fair problem, 
as well as a cleverly conceived one, and I shall try to 
solve it fairly. 

Analyze the series of transactions. Beginning with 



OTHER THEORIES OF INTEREST- 215 

the first transaction and going through the series, which, 
we are told, occupied a year's time, we find that 

A gives nothing (his note only) and gets " farming tools." 

The bank gives nothing and gets nothing. 

B gives " farming tools " (its notes only) and gets " materials." 

C gives the equivalent of $1000 and gets the equivalent of $1000. 

D gives the equivalent of $1000 and gets the equivalent of $1000. 

Etc. 

Etc. 

Z gives $1000 and gets " farm products." 

A gives " farm products " and gets nothing (the bank's notes 
only). 

The bank gives nothing (A's note only) and gets nothing (its 
own notes only) unless it gets interest. 

Note that in each of these transactions, except the 
first and the next to last, what occurs is merely the ex- 
change of something for something else deemed equiva- 
lent. And note that the first and the next to last, taken 
together, amount simply to this, that A has the use 
throughout the year of goods, to the value of $1000, 
which he does not own till the end of the year. 

Now Mr. Tucker asks whether in this whole circle of 
transactions there has been any lending of capital. Cer- 
tainly there has. The person lent to is obvious enough : 
he is A. If there has been any lending, asks Tucker, 
*'Who was the lender?" The lender is not obvious at 
all, but he is there just the same. For one day B is the 
lender, for one day C, and so forth : each man who ac- 
cepts the bank-notes of $1000 in exchange for goods is a 
lender of goods to that value from the time he hands 
over the goods for the notes until the time that he hands 
over the notes to somebody else for other goods. 



2l6 ■ A THEORY OF INTEREST 

And now we come to Tucker's last question : ''Who is 
entitled to any interest?" I reply that the people who 
are entitled to interest are all those who have done the 
lending or advancing, that is, everybody from B to Z 
and A. "Well, then," Mr. Tucker might reply, ''if 
they are entitled to the interest, why do they go without 
it, and why does the bank get it ? " I answer that they 
do not go without it, if they are good business men, ex- 
cept for the very short periods of time between the sale 
of goods for $1000 and the purchase of other goods for 
$1000, and that their motive for foregoing the interest 
for even so short a time is to secure instead the pre- 
sumably greater advantage of making the exchange of 
one lot of goods for the other lot, in which exchange the 
bank-notes perform a useful service. 

At this point in the argument Mr. Tucker would doubt- 
less want to ask what right the bank has to appropriate 
the interest which has been earned, according to my view, 
by the many traders. The answer is not far to seek : 
the bank performs for the very traders who earn the in- 
terest in question, not only the service of substituting 
its notes for A's note so as to make A's credit available 
for use as currency by men who would not know whether 
A's note itself is good or not, but also various other ser- 
vices which the bank must perform in order to secure the 
patronage that makes possible its securing of the inter- 
est in question ; and for these services all together the 
interest in question is just about reasonable payment. 
If it were more than reasonable payment, more and more 
persons would flock into the banking business, and more 
and more inducements would be offered bv banks to the 



OTHER THEORIES OF INTEREST 217 

public to secure their patronage, until the returns from 
banking would be just about what the same labor and 
capital could command in other enterprises. Thus it is 
arranged, as the result of laws and customs which, though 
faulty, no doubt, are nevertheless founded on the lessons 
of experience and not altogether bad, that the bank 
goes on performing the service in question and pays 
itself therefor with the interest which, as interest, is, 
accurately speaking, earned by the traders who are bene- 
fited by the bank's services. The reason why this ar- 
rangement works tolerably well is that the bank's services 
roughly correspond in value to the amount of interest it 
can appropriate in return for performing them. The ar- 
rangement is not perfect, but it is by no means so mon- 
strous as the Anarchists think. It would be monstrous, 
of course, if the opportunity to engage in banking were 
not freely open on the same conditions to all reputable 
persons ; but that is not the case. 

§ 105. I can easily imagine the denunciations that 
will be uttered against me by some Anarchists and 
Socialists who disagree with me in regard to the whole 
problem of interest. To such persons let me say here 
that I am not, as they might suppose, hostile to their 
hopes and aspirations, but on the contrary very friendly : 
I differ from them simply in opinion, after striving, long 
and hard, to discover and to express the truth. And, 
after all, it is only by doing just that fearlessly that men 
can hope to get rid of their differences. For, violently 
as they may disagree as they struggle towards the truth, 
it is only on the truth itself that men can come to perma- 
nent agreement. 



CHAPTER VIII 

Interest in Relation to Wages and Rent 

§ io6. We have seen that the indispensable condition 
of the nominal surplus called interest is the bearing of 
a cost by the advancer. Interest is just as truly earned, 
therefore, by the advancer who causes it by advancing 
services equitably belonging to him, as wages are earned 
by the hand-laborer or the brain-laborer. 

But this is not saying, it should be noticed, that all the 
interest received by a Carnegie, a Rockefeller, or a Duke 
of Westminster is necessarily earned by the man who 
receives it. A great part of the capital of such men, 
though belonging to them legally, does not belong to 
them equitably. I mean that a great part of it came to 
them neither as gifts from those who equitably owned it, 
nor as the earnings of their own labor, nor as the earnings 
from their own advancing of what was equitably their 
own, but as income from privileges. By this word 
''privileges" I mean simply titles (to income) which, how- 
ever honorably or however dishonorably acquired, — 
and in the case of some men of vast wealth they were 
acquired, so far as the individuals in question were con- 
cerned, honorably, — would not have gone to them if the 
laws and usages of society had been in accordance with 
the principles of justice as now conceived by the leading 

218 



INTEREST IN RELATION TO WAGES AND RENT 219 

economists. To put it more concretely, I mean by privi- 
leges such things as titles to the valuable services of land 
sites the value of whose services is due only infinitesi- 
mally to their owner and chiefly to the good citizens of 
the entire community ; I mean such things as unearned 
exceptional advantages in the use of ores or oil that no 
man made, or in the use of railroad rights of way that the 
whole public contributed to set aside for common uses ; 
and I mean by privileges such things as the power to 
charge buyers prices higher than they would have to 
pay if free to buy, without customs duty restrictions, 
of any seller they pleased. 

With my meaning clearer, perhaps, now, I repeat 
that any one who causes the nominal surplus called in- 
terest by advancing services that belong to him not only 
legally but equitably, earns that interest as truly as a 
laborer earns his wages. And if this be true, interest 
and wages should be classed, from one point of view, 
as the coordinate kinds of the general class, earned in- 
come. 

§ 107. We now have to consider the relation of in- 
terest to rent. 

First, then, what do we mean by rent? The word 
'' rent," besides being used in several senses in popular 
speech, has been used in several others in the writings of 
leading economists. For many years its accepted sense 
among economists — made famous by Ricardo — was that 
of income accruing to the owner of land in his capacity as 
owner merely, without labor on his part. Between 
Ricardo's time and ours the costlessness of the income 
accruing to landlords thus was strongly emphasized by 



220 A THEORY OF INTEREST 

Mill, Henry George, and many other writers interested 
in the cause of social justice, and a tendency grew up to 
think of costlessness as the very essence of anything 
that is to go by the name of rent, and therefore to ex- 
tend the use of the word to any costless income whatever. 
This tendency is deplored by Professor Fetter,^ who con- 
siders that "the essential thought in rent ... is that it 
is the value of the usufruct as distinguished from the 
value of the use-bearer or thing itself." ^ Which of these 
two meanings of the word deserves to prevail is a ques- 
tion on which I do not need to argue in the present in- 
quiry. There is much to be said for the first, and doubt- 
less there is something to be said for the second. It 
must be admitted that a brief name for all costless or 
unearned income is to be desired, and that the word '' rent ' ' 
is well fitted, by its long association with the unearned 
income from land, to serve in that capacity. On the 
other hand, doubtless the distinction made by Professor 
Fetter is of some importance ; and the word " rent " is 
well fitted by its commonest non-scientific uses to serve 
in keeping that distinction clear. But for my present 
purpose, which is to analyze the difference between in- 
terest and rent, I shall assume that by rent is meant 
privileged or unearned income, whether from land or 
from any other source. 

Taking rent in that sense, we find that interest, which 
from one point of view we classed as coordinate with 
wages as an earned income, is to be classed, from the same 

1 Chapter VIII of his Principles of Economics, The Century Co., N.Y., 
1907. 

2 The same, p. 55. 



INTEREST IN RELATION TO WAGES AND RENT 221 

point of view, as the antithesis of rent : whereas interest 
is an earned income, rent is an unearned. 

§ 1 08. But there are other points of view from which 
interest should be compared with wages and rent. Wages 
are not dependent on any other sort of income, and they 
arise independently of laws and customs. Most rent is 
dependent on wages or interest, being in fact merely the 
wages of the pubhc's labor and the interest from the pub- 
lic's investments to which inequitable laws and customs 
permit individuals to get title ; the only rent, indeed, 
that can reasonably be said to be not dependent on wages 
or interest is the income arising from the outright gifts 
of nature ; and all rent is the creature of laws and cus- 
toms. All interest is dependent either on wages or on 
rent, that is, either on what the advancer has earned 
or on what, though he does advance it, he has not earned ; 
but interest is like wages in that it appears and persists 
without the least help from laws. 

§ 109. In connection with these distinctions it is 
interesting to recall the errors in respect to interest made 
by the Anarchists and the Marxians, and to point out 
an error made by many of the Single Taxers. 

The Anarchists make the mistake of attacking, as the 
creature of government, ''interest," whereas the abhor- 
rent creature of government that they should attack 
is the quite different income that I am calhng ''rent." 

The Marxians make the mistake of denying that any 
interest is earned by the advancer, whereas that interest 
which comes in to the advancer as the result of his ad- 
vancing what he had really earned, his wages, is as truly 
earned by him as were the original wages themselves. 



22 2 A THEORY OF INTEREST 

As for the Single Taxers, many of them, indeed all 
orthodox or out-and-out Single Taxers, make the mis- 
take of confusing, under certain circumstances, the in- 
terest that they profess to have no objection to with the 
rent that they so zealously, and so effectively, attack. 
Consider a simple case. Here is Brown, let us say, 
who by labor has earned $1000. With the money he 
buys a lot of land from Smith, who bought it for $100 
when the town it is in was but a frontier village. The 
next day the orthodox out-and-out Single Taxers have 
their way, let us suppose, and arrange for the public to 
take as a tax one hundred per cent of the rental value 
of the lot. They defend their action, before you pin 
them down to close reasoning, by saying, in effect, 
merely that the value of the use of the lot was created 
by the pubHc, not by the owner, and that it is therefore 
right for the pubHc to take that value for itself. But it 
is clear that the person who has got the benefit of all this 
value created by the public is not Brown at all, but 
Smith. For Smith has in his pocket the $1000 that 
represents the sum of all the future services of the lot, 
discounted at the current rate of interest; and nine 
tenths of that amount is to him rent, unearned income. 
And Brown, though he has title to all the future ser- 
vices of the lot, got their full present value by earning it. 

The mistake of the out-and-out Single Taxers here 
consists in regarding Brown as a receiver of rent, in the 
sense in which I am using the word, merely because he 
receives an income derived immediately from land. 
Unless the lot appreciates in value after Brown acquires 
it. Brown receives from it no rent, in the sense of income 



INTEREST IN RELATION TO WAGES AND RENT 223 

not earned by him, at all, and Smith and his predecessors 
have already received all of it. Except in so far as the 
lot may go on appreciating in value, therefore, the horse 
has been stolen already. The income Brown receives 
from the lot, if he receives no more than he paid for (that 
is, if the lot does not appreciate in value), is simply its 
services which he bought of Smith at their discounted 
present value. So far as he is concerned, therefore, his 
whole income from the lot in such a case is nothing but 
interest. 

I am aware that orthodox Single Taxers seek to 
justify their program, when pressed by such argu- 
ments as these, by the plea that its benefits to the com- 
munity will be so great and so widespread that even 
the Browns will on the whole be better off for it. Grant- 
ing, for the sake of the argument at least, that this is 
true, it is not a sufhcient defence of the program. 
The undoubted immediate injury to the Browns from 
the adoption of the full Single Tax program should 
be borne not by them only, but by the entire community ; 
for it is the entire community that must be held re- 
sponsible for the legal institutions which give the un- 
earned income to the Smiths, whether they keep the titles 
to their lots or sell them, and which amount to a guaran- 
teeing of those titles to the Browns who may buy them 
innocently with money truly earned. 

"What," exclaim the orthodox Single Taxers, "you 
would buy out the present owners of land titles?" I 
certainly would. There is no organization in this coun- 
try, so far as I know, that stands for this program. 
The orthodox Single Taxers, who might be expected 



224 ^ THEORY OF INTEREST 

to favor, spurn it. And that the "practical" but rela- 
tively inequitable program of the orthodox Single 
Taxers will probably prevail over it I must admit. But 
it is the right program nevertheless. It is the right 
one, primarily, because it is the only one that accords 
with the highest justice we can conceive in the matter 
with our present knowledge. It is the right one, second- 
arily, because it is the least costly to society. All the 
land titles in this country can be bought ''on the in- 
stallment plan" by payments not exceeding the value, 
above their present market prices, of the titles to the pubHc. 
And even if they could not be bought without the 
bearing of a positive economic burden by the com- 
munity, they should be bought nevertheless ; for there 
are other burdens besides economic burdens to be con- 
sidered. How much did the Civil War cost this country, 
not only economically but vitally and morally, in com- 
parison with the cost of buying the freedom of every 
slave ? 

CONCLUSION 

§ no. This completes the outline of my theory of 
interest. Some mistakes will doubtless be found in it ; 
and even if found to be true in the main, it will be 
greatly developed by later writers. But it is as nearly 
true, and as complete in essentials, as I could make it 
without postponing its publication too long. I hope it 
will do good, especially in eliminating from party Social- 
ism — much of the spirit and some of the tenets of which 
society should adopt — a grave economic error that 
threatens seriously to pervert it. 



INDEX 



Words printed in italics are technical terms, and in most cases they are more or 
less formally defined on the pages the numbers of which tmmedtately follow 
them. 



Advance, 49, 47-49, three ways of 
making an, 49-52 ; to be distinguished 
from what is advanced, 49, 5 6-5 71 
not always embodied in discrete ob- 
jects, 63-64. Advance to persons, 52. 
Advance to nature, 52, 50-51 ; signifi- 
cance of, for theory of interest, 52- 
53 ; represented in Figures I and II 
(p. 48) and in Diagram III (p. 91) ; 
value of, 61-63 ; cost of, 64-66 ; sup- 
ply of, 66-68; point of contact of, 
with consumption, 103-104. Rela- 
tion of advances to persons to advances 
to nature, 52-53. 58-60. Relation of 
same to loan interest and to natural 
interest respectively, 54-55- 

Anarchists, vi-vii, 203-211, 217, 221. 
See also Tucker, Proudhon, and 
Monopoly. 

Aristotle, i. 

Ashley, W. J., 178. 

Banking facilities and rate of interest, 
111-112. 

Bastiat, F., 189. 

Bible. See Mosaic law. 

Bohm-Bawerk, E. von, author's obli- 
gations to, viii, 2 n. ; inadequate 
definition of principal by, 7-8, 7 n.j 
definition of vahie in terms of margi- 
nal utility, 27-32; "differences in 
want and provision for want," 117- 
123; "underestimation of future 
pleasures and pains," 123-124; 
"technical superiority of present 
goods," 124-146 (esp. 144)- 
Boninsegni, P., on "opheUmity," 43-46. 

Carver, T. N., definition of value, g, 
9 n. ; theory of interest, 1 5 7-1 59- 



Cassel, G., i n. 

Cause, 32-33 ; causal relations between 

value and cost, 21-25; number of 

causes of rate of interest, 105-107. 
Changing market, 17-19- 
Commodity, 13. See Good. 
Consumption, point of contact of, with 

making advances to nature, 103-104; 

increased, in relation to quaUty, i77- 
Cost, 19; determined by two factors, 

19; kinds of, 19-20; personal, 19; 

market, 19; nominal, 20; equation 

of value and, at margin, 21-23. 
Crusoe, natural interest may accrue to, 

88-89, 82; interest accrmng to, not 

to be defined in terms of price, 55-56 ; 

formula for rate of interest in case of, 

89. 

Davenport, H. J., definition of value, 

10, 10 n. 
"Depend," "dependent on," and other 

words involving conception of cause, 

26-33- , . . , 

"Differences in want and provision tor 
want" as cause of interest (Bohm- 
Bawerk), I I 7-1 23- 

Discount, 86, 5, 9, 86-87, 185, i94; 
formula for, 87; rate of, 87. 

Dishonesty, relation of, to rate of inter- 
est, 111-112. 

Distribution in relation to subjecttve 
factors of value, 25. 

"Durable consumption goods," 5-6, 55- 

Earned and unearned incomes, vi, 15 7, 
172-173, 177-178, 218-221. 

Estimation of advancer, 65, 71-72, and 
passim. See also Improvidence and 
Underestimation. 



225 



226 



INDEX 



"Exploitation" theory, as expressed by 
Marx, 159-170; criticism of, 170- 
175. See also Marx and Socialists. 

"Fallacy of saving," 176-178. See 

Robertson. 
Fisher, Irving, 2 n. 
"Fructification" theory (Turgot and 

H. George), 178-194; criticism of, 

193-194. 
"Future goods" and "present goods," 

need of exact definition of, 7-10. 

George, Henry, 178-193; his theory of 

interest, 185-193, criticism of, 193- 

194. 
Good, 13. 
Gossen, H. H., on conception of the 

margin, 150; on bearing of time for 

enjoyment on pain, 12 n. 

Heirs, possible influence on advancing 
of, 79-80; connection of, with rate 
of interest, 108-109. 

Hours of labor, not related to rate of 
interest as Marx thought, 172. 

Improvidence, relation of, to interest, 
8-9. See also Estimation. 

Interest, cause of, 5-6; causes of nor- 
mal rate of, 100-116; secret of prob- 
lem of, §§ 43-47, and references under 
Principal and Nominal value; in- 
dependent of wage system, 172-175 ; 
in what cases it must be conceived 
as a value instead of as a price, 55~56. 
See also Natural interest and Loan 
interest and Interest problem. 

Interest problem, difficulty of, i-io, 
esp. 4-5 ; importance of solution of, 
v-vi ; secret of, 73-85 ; relations 
of, represented geometrically. Chap- 
ter V (esp. Diagram III) (p. 91). 
See also Principal and Nominal 
value. 

Inventions, 6, 102-107, 109-110. 

Investment in consumption, 103-104. 

Justification of interest, vi, i, 157, 170- 
175, 176-178, 218-221. 



Labor, 13, 12-13. 

Labor-saving instruments. See Tools. 

Land, income from, in relation to word 
rent, 219-221 ; income from, in rela- 
tion to interest according to Turgot, 
178-184. 

Landry, A., 2 n. ; his theory, 194-201 ; 
criticism of, 201-203. 

Lassalle, F., 156. 

Life, duration of, in relation to the 
rate of interest, 108-109. 

Loan, 49. 

Loan interest, 2, 3-4, 54. 

Macfarlane, C. W., i n., 41 n. 

Macvane, S., 156. 

Management, efficiency of, and profits, 
172. 

Marginal utility, a term not needed in 
economic theory, 41, 26-27 ; its 
place taken in this book by " depend " 
and "dependent on, " 26-27 ; Bohm- 
Bawerk on, 27-32. See Utility. 

Market. See Market value. Market cost, 
Changing market, and Market in 
advances. 

Market cost, 19. See also Cost and 
Value. 

Market in advances, 34, 71, Diagram 
II (p. 69), Diagram III (p. 91), and 
passim. 

Market value, 16-17. See also Fo^mc. 

Marshall, A., 156. 

Marx, K., "Das Kapital," 3; ''aver- 
age rate of profit," 3; surplus value, 
4; his theory of interest, 159 n., iS9~ 
170; criticism of, 170-175. See also 
157, 177-178, 218-221, and references 
under Socialists. 

Men of affairs, interest theory of, 

3-4- 

Menger, Carl, 158. 

Mill, J. S., his definition of value, 9. 

Money and interest, 115, 212-217. 

Monopoly and profits, 172. 

Monopoly theory, 203-211; criticism 
of, 212-217, 221. See also Anar- 
chists, Proudhon, Tucker, and Mon- 
opoly and profits. 

Mosaic law and usury, i. 



INDEX 



227 



Natural capital, 63-64 ; not always em- 
bodied in discrete objects, 63-64. 

Natural interest, 3, 3 n., 54-56 ; more 
formally defined, 82. 

Nominal surplus (same as interest), 76, 
82-85, 97, 148, 157, 171-173, 176- 
177, 218 ; in relation to tools and ma- 
chines, 62-63. 

Nominal value, 17-19; subjective factor 
of, 19; objective factor of , 19; repre- 
sented geometrically, 48, 91, in con- 
nection with definition of the prin- 
cipal, 57-58; of advances to nature, 
61 n. ; algebraic equation of, 74-75 ; 
geometrical equation of, 91, 95. 

Normal ioinormally), 24, 23-24, 173 n., 
and passim; divergence of actual 
from normal conditions, in relation 
to the rate of interest, 111-116; 
normal price, 34. 

"Objective exchange value," 16 n. 

Objective factor of cost, 15 ; of pleasure, 
14; of value, 15; maybe the objec- 
tive factor of a value also, 20-21. 

Ophelimity, 14 n., 42-46. See Pareto. 

Pain, 1 1 ; its opposite, 1 1 . 

Pantaleoni, M., 12 n. 

Pareto, V., on ophelimity, 14 n., 42-46. 

Patten, S. N., 41 n. 

Pleasure, 11; its opposite, 1 1 ; on what 
dependent, 1 1 ; dependent on both 
objective and subjective factor, 13- 

15- 

Price, 34; normal, 34, theory of, 34- 
40, causes of, 40, of advances, 47- 
89, of advances represented geomet- 
rically, 69, 91, 90-98. 

Principal, 49, 57-58, 7-10; represented 
geometrically, 48, 91, 53-54; ex- 
pressed algebraically, 73-75 ; signifi- 
cance of author's definition of, for 
theory of interest, 76-77, 117; 
hitherto not correctly defined, 7-10. 

Privileges, 218-219, 173 n.; rent de- 
fined as income from, 219-220. 

Productivity, 146, 4, 146-148. 

Profit, in wide popular sense, 171 n. ; 
Marx's definition of, 169; relation of. 



to rent and interest according to 
Marx, 170; "average rate of,'' Marx's 
term for natural interest, 3. 

Protective tariff system and other causes 
that prevent producers from getting 
their dues in real wages, 179 n., 219. 

Proudhon, P. J., 203. 

Rate of Interest, 82 ; formula for nor- 
mal, 85 ; determined primarily in 
respect to advances to nature, 52-53; 
on loans, how determined, 53, 84- 
85 ; formula for, per cent, 85 ; rep- 
resented geometrically, 90-98 ; 
causes of, 100-116; actual, as modi- 
fied by a factor of risk, 114; apparent, 
115; cause of rise of, on value side, 
101-105, on cost side, 107-109; 
cause of fall of, on value side, 107, 
on cost side, 109; tendency of, at 
present, 1 09-1 10. 

Rent, 219-220; Fetter on, 220; rela- 
tion of, to interest, 64, 220-224, 173, 
173 n.; in Turgot's theory of inter- 
est, 178-185. See also Rent contract. 

Rent contract (sameas/ea^e), 49-50, 219- 
220; Fetter on, 220; distinction of 
interest contract from, 50. See also 
Rent. 

Risk, factor of, 11 4-1 15. 

Robertson, J. M., 176; theory of, 
criticized, 176-178. 

Roman Catholic Church and usury, i. 

"Sacrifice capitalistique," 194-203. 

Saving, "fallacy of." See Robertson. 

Seager, H. R., 41 n. 

Senior, N. W., his "a.bstinence theory," 
149-157. 

Services, 13. 

Single-Taxers, 221 ; program of most 
radical of, confuses interest with rent, 
222-224. 

Socialists, views on interest of, 3, 4, 6, 
159-175, v-vii, 221, 156 (Lassalle), 
176-178. 

Socially created "values," private ap- 
propriation of, 173 n., 222-224. 

Subjective factor of cost, 15. 

Subjective factor of pleasure, 14. 



228 



INDEX 



Subjective factor of value, 15, 16, 22; 
in the case of market value, 16, 23, 73 ; 
in the case of comparative personal 
and market value, 25 ; in the case of 
nominal value, 19; in the case of 
comparative personal and nominal 
values, 77-80. See also 43-46 and 
27-32. 

"Subjective use value,'' 16 n. 

Substitution, principle of, 37, 37~3^> 26- 
33; Bohm-Bawerk on, 27-32, 37. 

Surplus value, Marx's theory of, 163- 
165; Marx's theory of rate of, 165- 
166. See Nominal surplus. 

Tools, 61-63, persistence of interest not 

due to, 5. 
Tucker, B. R., 203, 208, 211, 214-216. 
Turgot, A. R. J., 178, 193 ; his theory, 

178-184; criticism of, 185, 193-194. 

"Underestimation of future pleasures 
and pains," as a cause of interest, 
123—124. See also Estimation. 

Utility, 13 ; its dependence on a sub- 
jective factor, 14 ; not the right word 



for properties measured by the curve 
OR in Diagram I (p. 36), 41. See 
Marginal utility. 

Value, 15 ; determined by two factors, 
15; specific kinds of, 16-19; pei'- 
sonal, 16; equation of personal value 
and personal cost at margin, 74; 
market, 16-17; nominal, 17-19; 
equation of cost and, at margin, 21- 
23, 38 ; correspondence of personal 
values and market values, 16, 19-20, 
23-25, 38-39, 60, 70-71; normal 
market, 34-39; non-worwo/, curve rep- 
resenting, Diagram I (p. 36) and 
page 42. See also Nominal value. 
Subjective factor of value, and Objec- 
tive factor of value. 

Wage-system and interest, 172-175. 
Waiting, 156, 156-157; productivity 

and, 157-158. 
Walker, F. A., on value, g, 9 n. 
Walras, L., 158. 

Want. See Differences in Want. 
Wicksteed, P. H., 17 n. 



